With banks shuddering and the venture capital shrinking, expect entrepreneurs to draw more heavily on that old standby — angel investors. So, who are they?
According to Gary Dushnitsky, a Wharton professor of management who studies entrepreneurs, angels are individuals who invest their own money in a business. Essentially, that is what differentiates an angel from a venture capitalist.
The latter may invest some personal funds, but most venture capital comes from an investment fund. An angel, on the other hand, opens a checkbook and draws from his or her own personal account. “An angel typically invests from tens of thousands of dollars up to one, two, maybe even five million,” says Dushnitsky. “Angels are attractive because venture capitalists are harder to meet.”
Angels usually know the entrepreneur personally; or an angel may be a friend of a friend. “Angel investors have been the secret love story of many start-up operations,” says Dushnitsky. “Angels are family and friends, a wealthy local doctor, or someone else who can offer you the funding you need to feed your venture.”
There are many successful entrepreneurs who subsequently reinvest their money as angels. But identifying who they are, what businesses they backed or how much they invested can be tough. “This is a private activity,” says Dushnitsky. “Because there are very few disclosure requirements, it’s hard to document.”
Angels usually invest in smaller operations. For example, an angel will fund the first location of a restaurant. Going beyond that stage requires larger sums of money. In this case, if the first restaurant is successful, the owner is likely to tap venture capitalists for financing to open the next three or four units in the chain.
But angels have a potential downside: because they get involved in early stages, they often use debt – as opposed to equity – to finance the business. That “could mean trouble,” notes Dushnitsky. For example, If a business is set up as a sole proprietorship or partnership, as opposed to some form of a limited liability corporation, the debt could become a personal liability. Plus, he notes, it could undermine a personal relationship if the business fails.
Says Dushnitsky: “When we talk about angels, we talk about leveraging one’s network.” It can also involve managing an angel’s network. Successful entrepreneurs often cite an “archangel” – their first investor who believed so much in the new business that he or she persuaded wealthy friends to open their checkbooks as well.
There’s another upside to angel financing: An angel investor may have extensive knowledge of the entrepreneur’s industry. And having “skin in the game” may encourage him or her to go beyond writing a check and waiting for an ROI. Angels with industry experience can be a valuable asset, especially to a less experienced entrepreneur. o a less experienced entrepreneur.