Angel Investors Finance Small Businesses

May 30, 2007 10:57 AM , By Gary M. Stern

Angel investors may be an alternative to banks and venture capitalists for some cash-strapped small businesses.

The banks rejected your loan application because your business didn’t show three years of growth. Venture capitalists won’t return your call because your revenue hasn’t hit $20 million a year. And yet you need an injection of capital to grow your business. Some entrepreneurs are getting the funding they need by turning to angels—not the mythic kind—but angel investors, high net worth individuals and groups who invest capital in start-ups and fast-track businesses.

In 2006 alone angel investors infused $25.6 billion in companies, almost as much as the $26 billion invested by venture capital funds, according to the University of New Hampshire’s (UNH) Center for Venture Research. However, venture capitalists funded only 4,000 U.S. businesses while angels put money into more than 51,000 companies, and expect that number to continue growing, according to the Center’s director, Jeffrey Sohl.

Angel investors operate differently than more traditional income sources. They don’t make loans like banks; they provide capital in return for equity in a business. Unlike venture capitalists, which start investing in the $2 million range, angels usually capitalize from $50,000 to $1.5 million, with an average in the $300,000 range. All require different degrees of due diligence, but Angels base their investments on a more visceral connection with the business in which they fund.

Growth Potential is the Key to Attracting Angels
Most angels are looking for “start up and early stage firms and companies that can grow in value quickly,” explains Marianne Hudson, executive director of Kansas City, MO-based Angel Capital Association (ACA), a professional alliance of investors. Angels look for innovative firms in a broad range of industries. Medical devices, biotechnology, software; business products and services; electronics and instrumentation; healthcare services; industrial/ energy; IT services; networking and equipment; and, telecommunications are all currently quite popular among investors, according to a recent ACA report.

Vegas Valley Angels for example, capitalizes in early and mid-stage companies with $1 million to $3 million in annual revenue that are poised to “grow to a minimum of $30 million in five years,” according to Bill Payne, one of its founders. “If they have a better mousetrap, know how to sell to a customer, have intellectual property and a management team that can start and grow the company, it will be considered.”

Angel investors appeared to be the only viable funding option for Mike Knight, founder and chief executive officer of Vanguard Mortgage & Title (Denver, CO), when he decided to seek a $1 million infusion to expand his business. “We didn’t have operating history because we’re in our 16th month of operations and therefore weren’t bankable (most banks require three years of financials). And, I didn’t want to relinquish 51% of my company forever to venture capitalists,” he says. Instead Knight turned to Gathering of Angels.

Gathering of Angles and Vegas Valley Angels are just two of a growing number of investment groups. Most angel investment clubs charge a modest $100 to $200 fee for the opportunity to solicit them for funds. However, these fees can run as high as $2,000+ for businesses also interested in consulting services to help investment seekers find angels and structure equity partnerships.

Knight attended Gathering of Angels’ monthly meetings in which the organization brings together 20 to 40 high net worth investment seekers. To stimulate interest and confidence in his business he provided financial documents and gave a PowerPoint presentation detailing the current state of operations and future plans for future growth. In turn, investors queried him regarding his background, track record, revenue and profits and qualifications for capital.

Knight spent $10,000 for four meetings (a $3,000 first-time fee plus $2,500 for each subsequent get-together). The time and money was well spent, says Knight. “If you measure the impact on my bottom line it was very effective for my mortgage business,” Knight says. He raised $100,000 (minus fees). Knight used the money for general working capital and lines of credit, which enabled him to acquire licenses in more states and expand his business.

Is Angel Funding Right for you?
Like any other funding agreement, there are strings attached. So, before you start praying for an angel, there are key issues to consider:

Angel investors make equity deals. That means they give you money and in turn own part of your business. The owner sells stock in their business to angels, just the way public companies sell stock to shareholders. If the business is valuated at $1 million, and the owner is looking for $200,000 in capital, the owner is selling a 20% stake in the business.

Investors acquire an average 23% equity and often obtain two or three board seats. Even though they don’t own a majority share they can still exert considerable influence on policies and direction, says Sohl.

However, many angels are former entrepreneurs themselves and invest in businesses in which they have expertise. Some small business owners enjoy these new partners and profit from mentoring, advice and connections as long as they share a similar vision, says Sohl .

But beware, once an entrepreneur accepts funding, “there’s no divorce and no exit,” Sohl says, suggesting that the company will be sold or go out of business if it’s not successful.

Individual angels and groups all have one thing in common: they are writing you a check, and surely want a return on their investment. Terms of each deal are unique, but often require the owner to take the company public or sell it to pay their “debt.” The idea of potentially parting with their businesses— no matter how lucrative that may be— is one deterrent for some business owners.

“I’ve had one company sell in 18 months. We usually aim for 5 to 7 years, but sometimes it takes longer,” says Payne. There are also long-term investments. For example, Payne and two investors at San Diego Tech Coast Angels put $500,000 in Vista Staffing Corp., a physician placement service. After 16 years and considerable growth Vista was sold for $70 million.

Resources:
· Professional organizations like the Angel Capital Education Foundation and Angel Capital Association offer directories of angel investors along with links to their websites. They also provide additional resources for business owners.
· Angel Investor News produces a monthly e-newsletter with articles, book reviews and additional resources for investors and business owners alike.
· The National Association of Seed & Venture Fund offers research, events, and other resources for business owners and those who wish to invest money in their local communities.

Article posted on AngelNetwork.com Blog by HHolmes. 

Source: http://smallbusinessreview.com/finance/angel_investors_finance_small_businesses/.  Small Business Review is published by Penton Media for successful small business owners and executives.