Angel investors are wealthy individuals who provide capital to help entrepreneurs and small businesses succeed. They are known as "angels" because they often invest in risky, unproven business ventures for which other sources of funds—such as bank loans and formal venture capital—are not available. "Unlike banks, which hold you to stiff rules, offer little guidance, and are reluctant to make loans to start-up companies, angels can act as mentors, providing encouragement, contacts, and cash while staying out of the day-to-day business," Ellie Winninghoff wrote in an article for Working Woman.
According to Nation's Business's David R. Evanson, wealthy private investors provide American small businesses with $10 to $20 billion annually, which "dwarfs the investment made by traditional venture capital partnerships and offers a viable source of financing for capital hungry entrepreneurs." These individuals want to invest in up-and-coming new companies not only to earn money, Evanson suggested, but also to provide a resource that would have been helpful to them in the early stages of their own businesses. In many cases, the investors sit on the boards of the companies they fund and provide valuable, firsthand management advice.
Like other providers of venture capital, angel investors generally tend to invest in private startup companies with a high profit potential. In exchange for their funds, they usually require a percentage of equity ownership of the company and some measure of control over its strategic planning. Due to the highly speculative nature of their investments, angels eventually hope to achieve a high rate of return.
For many entrepreneurs, angels include friends, relatives, acquaintances, and business associates. In fact, Winninghoff noted that nearly 90 percent of small businesses are started with this type of financial help. Some entrepreneurs gain access to angel investors through venture capital networks—informal organizations that exist specifically to help small businesses connect with potential investors, and visa versa. The networks—which may take the form of computer databases or document clearinghouses—basically provide "matchmaking" services between people with good business ideas and people with money to invest.
Although an angel can seem like the answer for an entrepreneur who is desperate for capital, it is important to evaluate the person's motives for investing and need for involvement in the day-to-day operations of the business before entering into a deal. "More and more entrepreneurs are turning to angels," Winninghoff noted, but "many are finding that partners aren't always silent or willing to sit passively on the sidelines. In fact, while they may be brilliant in their own fields, many saviors have little understanding of the entrepreneurial process. Often they invest for the wrong reasons, or with unrealistic expectations…. Knowing how to recruit the right angel and avoid the pitfalls of dealing with him or her can mean the difference between a solid financial foundation and a failing venture."
In an article for Entrepreneur, Evanson and Art Beroff described several basic personality types that tend to characterize angel investors. "Corporate angels" are former executives from large companies who have been downsized or have taken early retirement. In many cases, these angels invest in only one company and hope to turn their investment into a paid position. "Entrepreneurial angels" are individuals who own and operate their own successful businesses. In many cases, they look to invest in companies that provide some sort of synergy with their own company. They rarely want to take an active role in management, but often can help strengthen a small business in indirect ways.
"Enthusiast angels" are older, independently wealthy individuals who invest as a hobby. As a result, they tend to invest small amounts in a number of different companies and not become overly involved in any of them. "Micromanagement angels," in contrast, usually invest a large amount in one company and then seek as much control over its operations as possible. "Professional angels" are individuals employed in a profession such as law, medicine, or accounting who tend to invest in companies related to their areas of expertise. They may be able to provide services to the company at a reduced fee, but they may also tend to be impatient investors. Evanson and Beroff stress that understanding the needs of various types of investors can help entrepreneurs to develop positive working relationships.
Regardless of the type of angel a small business owner is able to recruit, there are a number of methods available to help avoid potential problems in the relationship. Entrepeneurs should, for example, be very frank and honest when describing their business idea to a potential investor. Entrepreneurs should also interview potential investors to be sure that their goals, needs, and styles are a good fit with the small business. It is important to ask questions of potential investors and listen to their answers in order to gauge their needs and interests. Ideally, the angels' investment approach will be compatible with the entrepreneur's needs. "Entrepreneurs need to keep in mind that partnerships between angels and entrepreneurs are like marriages, involving issues of compatibility and cash," Winninghoff wrote. "Even the best business relationships will need work. In fact, the success of the small business depends on equal parts diplomacy and profit."
Evanson, David R. "Venture Capital, Networks Proliferate." Nation's Business. September 1996.
Evanson, David R., and Art Beroff. "Heaven Sent: Seeking an Angel Investor? Here's How to Find a Match Made in Heaven." Entrepreneur. January 1998.
Fenn, George W., and Nellie Liang. "New Resources and New Ideas: Private Equity for Small Businesses." Journal of Banking and Finance. August 1998.
Hosmer, LaRue T. A Venture Capital Primer for Small Business. Washington, D.C.: U.S. Small Business Administration, 1990.
Schilit, W. Keith. The Entrepreneur's Guide to Preparing a Winning Business Plan and Raising Venture Capital. Englewood Cliffs, NJ: Prentice Hall, 1990.
Winninghoff, Ellie. "The Trouble with Angels." Working Woman. March 1992.