Angel investors come into a deal earlier than venture capital firms. Angel investments are much smaller than venture capital. They may be as little as $100,000 to start the business.
Angel investors are often friends and family. They may also include a pool of wealthy individuals or a fund that regularly makes these early-stage investments.
One of the primary considerations when it comes to angel investments is whether the deal is priced or uses convertible debt.
The Priced Deal
The priced deal is one where the angel investor and entrepreneur agree on the value of the start-up at the time of the investment.
For example, if the parties agree that the price is $1 million, the investor takes an ownership interest equal to whatever amount they contribute. A $333,333 investment results in a 33% ownership interest.
This option can be difficult in that it is hard to agree on a price. From the entrepreneur’s side, they may fear giving up too much of an equity stake in the business. From the angel investor’s side, they are the ones taking the financial risk. This risk is that the business will not be viable and not be able to have other later-funding rounds to buy them out.
Convertible Debt
Convertible debt is a loan that converts to equity at the close of a later funding round. With this option, the price is basically set by what the funding round can bring. The equity is set at a discount to the price the venture fund investors get.
From the entrepreneur’s side, this can help them preserve their equity position in the business. From the angel investor’s side, this can help them get into competitive deals quicker as they do not have to negotiate or haggle over pricing.
Experienced vs. Inexperienced Angels
We see both priced deals and those that use convertible debt. Each has its place.
While there are important considerations for both, one common factor that impacts both is the sophistication of the investor. Sophisticated investors will do everything they can to help the business succeed. This includes making introductions and providing input as to strategy and procedures.
Less sophisticated or hands-off investors won’t do any of these things. They will simply be looking for a return on their investment. A fund composed of wealthy individuals is an example. They may not view it as their job or view it as being appropriate for any one investor to step up and really help the business be successful.
A business can benefit greatly from an active angel who has experience growing businesses. A business can also benefit from an absentee investor who lets the business spend more time finding market fit rather than producing revenues. The opposite is also true, at times.
This experienced vs. inexperienced investor factor is often more important than the type of the deal–be it a priced deal or one that uses convertible debt. If you are thinking about taking angel funds, you should consider what you need or what from the angel themselves. Then consider their terms.