Angel investors fund more companies than any other source of capital for start-up ventures — except for entrepreneurs themselves, their friends, and their families. Not surprisingly, angels tend to invest in new ventures in business sectors they understand, says Bill Payne, the 2010 Bank of New Zealand University of Auckland entrepreneur-in-residence at The ICEHOUSE, an Auckland-based business incubator. While angel investments cover the spectrum of start-ups, most specialize in a single or narrow set of business verticals, such as software, energy, or medical devices. Other angels choose to fund low-tech ventures, such as retail, growth services, and manufacturing. When angels consider funding a start-up, they look for common characteristics among those companies, Payne says. Here are the criteria for investment used by most angels:
- Angels bet on the jockey, not the horse. A qualified, coachable entrepreneur and management team are the first consideration. “A ‘B’ team is unlikely to be successful in commercializing an ‘A’ product, but an ‘A’ team will quickly upgrade a ‘C’ product into a viable business,” according to Payne.
- Angels invest in start-ups that can ramp revenues to US$25 million or more in five years. Rapid scalability is important. If one in 10 angel-funded start-ups must provide all of the portfolio’s ROI, angels must bet only on potential home runs.
- Angels fund ventures with customer-ready products or services. Investors want to talk to customers or potential customers to confirm that the product or service meets an important need. “Angels invest in painkillers, not vitamin pills,” Payne says.
- A competitive advantage – a patent, trade secret, or huge head start in the technology space – is important to angels. They don’t fund companies with products that can easily be duplicated by more mature companies with deep pockets.
- Angels seek companies with solid sales and marketing plans. They fund entrepreneurs who know that products or services don’t sell themselves and understand the channels they must use to reach customers.
- Angels prefer to invest in local companies so they can kick the tires before investing and then coach, mentor, and serve on boards of directors of portfolio companies. Most are part-time investors with multiple interests, and many are motivated to give back to their communities by investing locally.
- Angels tend to invest US$200,000 to US$1 million in the first outside round of funding for new ventures at a valuation of $1 to $2 million and hold equity stakes of 20% to 40% after the first round of financing. Angels are not lenders who expect to be paid back with interest, but equity investors who purchase ownership in start-up companies.
- Angels expect entrepreneurs to have an exit strategy that will enable both the entrepreneur and investors to sell the start-up within five to 10 years, providing shareholders with a substantial return.
For all of their trouble and risk-taking, there is good evidence that patient angels can earn about a 25% internal rate of return when measured over a 10-year period.
Source: NZ Herald News