By Amber Erwin
Last updated:September 8, 2022
Achieving funding for your startup isn’t easy. You have toreach out to potential investors and pitch your idea in a waythat is appealing and can provide advantages and showpotential. Securing funding from investors is essential topaying upfront costs for materials, space, and a team to helpyou get your startup off the ground. One funding source thatstartups can leverage is by pitching to angel investors.
Angel investors are wealthy individuals who finance smallbusiness ventures and startups with their funds. AngelInvestors often were former founders and entrepreneurs whoseek out small businesses and startups during the beginningstages of growth. When you secure an angel investor, yousecure much more than just their money. You secure theirexpertise and their network.
While working with Angel investors can be beneficial, theycome at a cost. Angel investors will invest a healthy sum ofmoney but expect a stake or equity in your company in return.Giving up a sizable stake in your company can be difficult,but it’s expected when working with angel investors. Figuringout a fair sum is dependent on a lot of factors. This articlewill give you a good idea of how much equity you should offeryour Angel investors to encourage them to move forward withtheir investment.
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Benefits of Working with Angel Investors
Funding from an angel investor can be one of the morebeneficial ways to take on funding as you’re working ongetting your startup off the ground. Angel investors are lessrisky than taking out a small business loan, and you don’thave to take on debt to partner with an angel investor. Ifyour startup fails, you don’t have to worry about paying thedebt back, as most angel investors understand their risks andknow the long-term returns if the startup is successful.
Not only do you benefit from their financial backing withouttaking on debt, but you also get to utilize their wealth ofknowledge and experience running a business in your industry,as many angel investors are former founders and businessowners. You also get access to their network of connections tohelp you learn more about running your startup and potentiallygive you partnerships that can help you transform your startupinto a profitable business.
How Much Equity Should Angels Get in 2022?
Angel investors place a high value on your startup’s strengthbased on your company’s evaluation. They understand thatinvesting is a long-term commitment. The funding provided byangels often comes from an individual, and the money is from abusiness entity, trust, investment fund, and other sources.
They are investors who understand the risks of investing instartups and expect a decent return in the form of equity.There is no hard rule on the amount of equity they receive inexchange for financial support. The amount of equity angelinvestors typically seek averages around 20 percent, with somebackers asking for as high as 50 percent stake in yourstartup.
The risk is high for angel investors with over 90% of startupsfailing, and to help mitigate that risk, these experiencedentrepreneurs will often ask for more to safeguard theirinvestment. It can be in the form of a seat on the board ofdirectors or by bringing in professional consultants andexecutives to help manage and grow the business.
These safeguards expand the angel investors’ control over thestartup, and while there are many benefits, it can be hard tohand over control and can cause issues down the line.Negotiations are key to developing a strong relationship withyour angel investors while setting boundaries to ensure youcan build your startup as you want with little interference.
How to Determine an Angel Investor’s Equity
Every investment from an angel investor is as unique as thestartup itself. Before seeking out angel investors, you’llwant to value your company during the seed round of funding.It can be difficult during the initial stages of a startup ifthere are no trackable growth rates, cash flow, or othermetrics that could potentially help determine your startup’sworth.
Company Valuation
There are multiple methods of determining your startup’s valuewithout any cash flow. The most commonly used method is thescorecard valuation, which is usually what angel investors useto determine how much to invest. The method compares thestartup to similar angel-funded startups during whicheverstage of development the interesting startup is in toestablish a pre-money valuation.
Angel investors are more interested in startups during theirinitial stages or pre-seed or seed stages of financing. Theyinvest in companies that show promise and potential to providea significant return on investment. Angel investors willusually receive a higher return during these stages, makingthe investment more profitable.
How Much Money Your Startup Needs
Before you begin contacting investors, you need to determinehow much you need to cover your expenses during this stage ofyour business. You’ll need to work out calculations on howmuch you’ll need to cover expenses such as:
- Operating costs
- Employee wages and salaries
- Marketing
- Development
- Office space
- Equipment
You’ll need to calculate the period you expect funding tocover, whether it’s 12 months or longer. Include a contingencyamount to account for emergencies to evaluate what you needfor your business and operations to present to angelinvestors.
Investment Size
The equity in your startup is negotiated once you’ve presentedyour business plan to a potential angel investor, along withyour company’s valuation. The equity stake varies betweenevery angel investor, but it comes down to their investmentsize and what they would like to see in return based on thenumbers you provide them with your pitch deck.
Angel investors look for enough equity to get a significantreturn on their investment; usually, their involvement isminimal. While the investment is long-term, Angel investorswill require an exit strategy for them to take what they’veearned and leave the company in the hands of the founders onceit’s profitable.
How do Angel Investors Exit and Earn Money?
Exit strategies are the most common way that angel investorsmake their money. The exit is when an investor decides to endtheir involvement with a startup and can be done a fewdifferent ways. The exit allows the investor to sell theirstakes in the company and move on. The exit is usuallypre-planned during the negotiation period of investing in astartup.
The most common ways angel investors get their exit andreceive their return on their investment are:
Buyback – Once the startup is successful andprofitable, the founders will repurchase the shares from theinvestors at market value.
Larger Investors – As the startup shows signsof success and begins to raise funds in later rounds, angelinvestors can begin their exit. Larger investors couldpotentially buy the shares in the company if they want morestake, but it must be approved by the founders and the companyboard of the startup.
Acquisitions – Startups often end up beingacquired by larger companies in their industry. Largercompanies look for smaller startups to help grow theirbusiness inorganically and remove potential competitors.Angels will usually end their involvement when this occurs byreceiving equity in the new organization or by a cashout.
Initial Public Offering (IPO) – When thestartup goes public and offers shares and stocks for thepublic to buy, the IPO allows angel investors to sell theirequity to the public. Although this stage is rare to meet,it’s an easy exit strategy for the angel investor to get theirreturns and move on to their next venture.
What is the Average Time for Angels to See a Return?
Angel investors take a large risk in investing, and the timefor them to see a return is often lengthy, if ever. If thestartup venture fails, angel investors will not see a profitat all. Early investors usually can expect to see returnswithin an average of five to seven years. Some investments cantake as long as ten years to see a return. Angel investorstypically seek to recoup their initial investment at least andearn a return profit.
Receiving funding from angel investors usually requires givingthem a percentage of your company in return for theirfinancial backing. Be sure you know your company’s valuationto help you determine a fair share between you and yourinvestors. You can expect, on average, to provide angels withat least 20 percent of your startup during the initial stagesof building your business. While the investment may seem likea lot in the beginning stages, you’re receiving valuable moneythat can help you turn your idea into a reality.
