February 12, 2020

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by: Jonathan Hung

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Categories: Angel Investor

What Do Angel Investors Look For In A Startup?

Receiving funding as a startup isn’t easy. There are so many competitors and, comparatively-speaking, so few investors. This fact often means that startups are competing for a limited pool of dollars. As such, it’s essential that your startup “checks all the boxes” of what investors want to see.

Often, your first investors will be angel investors. This type of investor looks for very early-stage companies that show a lot of promise. The investment amounts are not massive – they might be as little as $25,000 or as much as $200,000 – but they are vital to the success of a company in its relative infancy. Plus, once a business receives one angel investment, it makes it easier to convince others of the value of the company and get them to invest as well.

Since receiving these initial investments is so vital to the success of your company, it’s essential to know what angel investors look for in a startup. Since each investor is different, there is no definitive all-encompassing list. However, here are five prerequisites that most angel investors are going to want to see your business have before investing in it.

  1. The Top Thing Angel Investors Look For In A Startup? Money Potential.

It can be easy to get so caught up in the frenzy of your business and how your idea is unique or socially useful or will have some other positive impact on society. However, if your business doesn’t have the potential to earn lots of money, it will be challenging to solicit an angel investor.

When Peter Thiel invested $500,000 in Facebook as an angel investor, his investment eventually ballooned into $1 billion. While your startup may or may not be the next Facebook, angel investors know how risky their investments are. Many of them will be for a loss as businesses are relatively likely to fail within the first few years of operation. Therefore, their investments in companies need to have the potential for a solid ROI.

Since angel investors are frequently individuals that have different risk tolerances, there is no one single metric that encompasses how much ROI angel investors look for in a startup. Some reports suggest that angel investors should look for ROIs of 30-40%.

Part of convincing an investor that your business has significant money-making potential is by having a detailed business plan. You should already have this since it’s incredibly useful for other things (obtaining loans, in particular), but if you don’t, you should create one. Your business plan should include your forecasts, how you arrived at those profit figures, and also show that an angel would have room for investment growth. If your business plan is rock-solid, it’s much easier for investors to digest and become an advocate for your business!

If you can convince an investor that your idea has the potential to make significant sums of money, then you’ve already won half the battle!

  1. Business Structure Amicable To Angel Investing

There are many ways to form a company. At the most basic level, there are four types of businesses: C corporations, S corporations, LLCs, and sole proprietorships. Of those business types, generally, S corporations and C corporations are favorable to angel investors. S corporations are much more straightforward for founders as they offer pass-through taxation, thereby eliminating the double taxation problems of a C corporation. Since, however, S corporations have a board of directors and the legal status of a full corporate entity, they are still valuable in the eyes of angel investors. At the B and C rounds of funding, however, VCs will sometimes expect to see that structure transition to C corporation status.

Since S corporations cannot issue multiple classes of stock, typically, angel investors will request a SAFE (simple agreement for future equity) note. These notes are agreements to purchase shares in a company at a reduced price. An example of this might be that an angel investor will agree to invest $50,000 in exchange for a percentage of series A preferred stock once the company gets to that stage.

The world of SAFEs could undoubtedly be an article in and of itself. This post discusses them in-depth, including all the possible variations for startups. However, whether or not you use a SAFE, an S corporation, or even a C corporation, you should structure your business early on so that you can take on outside investors. A sole proprietorship or LLC typically will not suffice for those reasons. You should register a full corporation with your Secretary of State and elect for S status with the IRS to start. Then, as your company grows, you can always convert it to a C corporation later.

  1. An Exit Strategy

Typically, an angel investor has a desired amount of money that they want to make, and then they want a way to close their position in your business. Remember that their goal is to provide you with the funds and guidance to grow. In turn, they hope your business succeeds, and they receive a healthy ROI on their investment.

For example, an angel investor might take a 10% equity stake in your company in exchange for $50,000. An investor might want to take a look at your business plan to see what your sales projections are. Perhaps the investor will then want to have an exit strategy that once the business has $200,000 in the bank, it will buy back the shares using $100,000 of those funds, thereby doubling the original investment.

Of course, every investor is different, but each one of them wants to make money off their capital. As such, they’ll want to see a strategy that enables them to “cash-out” and recoup their initial investment plus some extra.

  1. An Amazing Team

Although it might seem counterintuitive, more often than not, angel investors are not investing in the business. Instead, they’re investing in the people that make up the business. Great business owners know their strengths and weaknesses. They also have a proven record of delivering success. For example, one of the founders might be a fantastic salesperson but a poor accountant. Another one of the founders might be a great accountant. Or, perhaps they have hired a well-known CFO to ensure things are running smoothly.

Especially at the earliest stages, businesses comprise the people. Angel investors want to see people who can handle the pressures involved with all things “startup.” They want to see people who have track records of knocking it out of the park and then some.

If you don’t have a track record of running a successful business before this one, consider including someone in your company who has that type of history. It may make it seem more investable in an angel’s eyes.

  1. A Personal Commitment

If the founders have no commitments to the business themselves, it can be hard to solicit angel investors. Many people erroneously assume that angel investing replaces personal investments or investments from friends and family. This assumption is incorrect.

If you form a company the right way and only have an idea, angel investors won’t invest. You’ll need to put some of your capital first. You’ll need to find friends and family who believe in your idea and invest some initial seed money into the business. Having these initial funds is what gets your business started.

Once your business is off the ground and showing some promise, angel investing is what takes your business to the next level. These investors help you grow your business through money as well as expert guidance via a seat on the board of directors.

Without evidence of genuine commitment to your business with your own money, it’s hard to convince others to invest. Therefore, ensure that you use at least some of your money first before soliciting investments from others.

There Are Multiple Factors That Angel Investors Look For In A Startup

Creating a startup that is attractive to angel investors is sometimes a little easier said than done. The most significant driving force for these investors is your business’ profit potential. Without that, it’s both nearly impossible to get an investor, and it’s equally challenging to succeed without a solid plan to make money.

Once you have a money-making idea, you need to ensure your corporate structure is friendly to these types of investments. If it isn’t, then you could find it challenging to attract angels. These types of investors look for a well-defined exit strategy and a robust team with a track record of delivering incredible accomplishments. Finally, angels also look at other aspects of your business – like if you have bothered to invest your money into it. You are much more likely to be motivated when your capital is on the line.

Attracting an angel investor is not impossible. There are many investors out there that are searching for fantastic companies in which to invest. It’s often incredibly profitable for them to do so. By ensuring that your business has all the attributes that angel investors look for in a startup, you should find it much easier to find these investors!