Banks and investing institutions aren't the only ones providing funding to small businesses. Learn how to work with private investors, business angels and other alternative forms of financing that won't require you to go public.
Considering many entrepreneurs start their own businesses because they bemoan a complex, bloated corporate structure and like to keep things casual, it's no coincidence many of them also seek less formal financiers.
While that sounds like a pipe dream, it's actually a reality for a sizable portion of the small business community. To be clear, no financier—or at least no good financier—will give you his or her hard-earned money without checking out your business and its finances. These private investors are often called “angels,” and as you'll learn, they've earned that nickname for good reason.
Finding an angel investor for your business
Most angels are former business owners themselves. Many sell their companies but haven't lost the itch of entrepreneurship, so they spend a little (or a lot of) time helping small business owners by providing funding and, occasionally, expert advice.
They get what you're going through, but they also know what separates a so-so small business owner from a great one who deserves their funding. They can be, or not a likely target for, a venture capital firm. Although angels tend to be less demanding in their financing terms than venture capital firms, you should still exercise great caution in ensuring that your “angel” financier doesn't turn out to be a devil in disguise.
What do angels look like?
Frequently they are other small business owners, or former owners, in your community. And, there are angel networks that can put you in touch with potential investors around the country.
No standard angel profile exists, but these investors are often individuals or groups of either local professionals or businesspersons who are interested in assisting new businesses that will enhance the immediate community. They are not typically interested in controlling the business, although they usually want an advisory role. In addition, they may make financing contingent upon the business's adherence to certain goals or practices.
Most entrepreneurs already recognize that potential “angel” investors for their business might be just about anywhere. Networking within your community and your business circles can often provide a good starting point. Potential financing contacts can arise through your business associates, affiliations with relevant trade associations, inquiries through your local banker, accountant or attorney, local chambers of commerce, and through other small business entrepreneurs.
When looking for angel investors, do your best to shop for smart money. In other words, try to get more from an angel than just financing.
Many angels will serve as advisers, or on a board of advisers, to offer the value of their experience and strategic advice on operating the enterprise. In addition, the angels will frequently use their own connections to assist the business in finding additional financing growth opportunities, favorable suppliers, new customers, etc.
The terms of angel financing depend entirely on what you can negotiate with a particular investor, but almost any type of debt or equity financing is a possibility.
Some angels may offer loans at very low interest rates simply to help a new business or the community; others may expect specific rates of return on an equity investment. Some deals involve a debt instrument that allows the investor an option to convert the debt into an equity investment at either a specified time or if certain conditions are met. The investor can thereby protect himself or herself by retaining a debt claim if the business does not do well or can profit by converting the interest into equity ownership if the business succeeds.
Most commonly, however, angels will want an equity interest in the business and some guaranteed “exit” provisions, such as a mandatory buyout, a “put” option requiring the business to repurchase the stock at the investor's option, or a public offering of stock. In a five-year period, angels might expect a return on investment of three to five times their initial investment, while a venture capital firm might want a return of five to 10 times its original investment.
Angel networks as a source of financing
Pounding the pavement isn't the only method to finding an eager angel. A growing cottage industry of angel network firms are dedicated to matching prospective investors with small businesses. You're able to find the financing you need, and angels are exposed to more investment opportunities.
How angel networks work
Angel networks function a lot like dating services.The basic idea of any angel network goes like this:
- You and the investor each pay a subscription fee to be included in the match-making service.
- You prepare a business profile identifying traits such as the relevant industry, the business's age, geographic location, size of investment needed, and any conditions or factors that the entrepreneur requires. (And you thought a completing dating profile was taxing.)
- The investors completes a similar profile, detailing the kind of company they are looking to invest in and the type of investment they are willing to make.
- The angel network takes all of the data you and the investor have provided and uses its own algorithm to determine good matches.
- You and the investor are put on a limited listed so you can make contact.
- You start on an investing match made in heaven...well, at least a match involving an angel.
Don't sign up with the first angel network you encounter. Do your homework and find one that you feel comfortable with.
The angel network will not set up a conference call or serve in any type of middleman role between you and the investor. The responsibility of contacting each other and (we hope) signing on the dotted line falls entirely on you and the investor.
Some angel networks include private investors and venture capital firms in their databases. If you're not interested in financing from VC firms, be sure to mark that preference in your subscription sheet.
As a general rule of thumb, your relevant work experience is the most important factor to angels. They want to know if you have a track record of pulling off the difficult tasks required to make a big success out of a small business. While startups have been funded through these networks, many angels prefer their investees to have at least a minimal operating history. If it were your money, you'd like to invest in someone with applicable experience before risking your personal funds.