Working with an angel investor seems ideal for small businesses, especially startups. However, it’s not without its challenges.
Financing through angel investing is based on equity. And this makes it perfect for businesses that don’t have the initial funds or collateral for loans.
For the purpose of starting a new company, this financing method is the middle ground between bootstrapping or family funding and extensive business loans.
Although angel investing provides apparent benefits for a small business, this model still has specific disadvantages that shouldn’t be overlooked. Here are the most significant pros and cons of working with an angel investor.
Ideal for Start-ups
The essential requirements for securing an angel investor’s support are a solid business plan and a convincing demonstration. Financial institutions, on the other hand, will require proof of profitability, a sturdy business model, and collateral with startup loans.
This makes angel investing more readily available for startups than loans.
Family and friends can also provide the starting funds, but they might be limited. Angel investors, meanwhile, are likely to have the necessary funds.
It’s not a Loan
Because angel investing functions on equity, it comes with specific rules. Most important of which is that the investor will want a stake in the startup and they usually have an exit strategy if the business doesn’t take off. This means there’s no monthly payment obligation.
A significant downside of loans is that the startup owner is liable even if their business plan fails. With angel investors, no direct payoff is expected.
No Risk-Based Limitations
Angel investors most often have no problem taking a risk on a startup that shows potential. However, this doesn’t mean they are reckless. Angel investors are usually successful entrepreneurs with plenty of experience and they pull the funding from private equity. Also, they often work within a network that can dilute the risk.
Because an angel investor is directly involved with the startup’s success, they expect high returns and often exert intense pressure in that regard.
Setting the bar high comes naturally with this type of financing, which compensates for the higher risk and no monthly obligations towards the investor.
With a stake in the business, angel investors can partially take control of the company. Since they are often experienced entrepreneurs, their more decisive influence on business operations could be seen as advantageous.
Still, business owners are never too keen on relinquishing control and having limitations on their choices. The dynamic and amount of control that the owner gets to keep over their company will depend on the circumstances. There’s a risk involved with the direction of the business going forward, perhaps equivalent to the investor’s initial risk in financing the startup.
Working with Angel Investors
As with most business-related matters, securing financing through an angel investor comes with advantages and disadvantages. Those can turn out to be relatively well balanced, as the risks and returns become mutual. Finding the right angel investor could prove to be the best way of taking a startup off the ground.