Angel investors invest in early-stage startup companies in exchange for a stake in the company. Angel investors hope to replicate the high-profile successful investments made in companies like Airbnb, Facebook, Instagram, WhatsApp, Uber, and more. Angel investors typically make small bets ($25,000 to $100,000) with the hopes of getting “home run” returns.
Angel investors understand that startups have a high risk of failure. So ultimately an angel investor needs to feel confident that the potential upside/rewards from investing are worth the downside risks.
Angel investors review a variety of key issues and undertake due diligence before they invest in a startup. In this article I discuss the key items angel investors analyze in deciding whether or not to invest in a startup.
1. Is there a great founder/management team?
Many investors consider the team behind a startup more important than the idea or the product. The investors will want to know that the team has the right set of skills, drive, experience, and temperament to grow the business. Anticipate these questions:
- Who are the founders and key team members?
- Have members of the team worked together before?
- What relevant domain experience does the team have?
- What key additions to the team are needed in the short term?
- Why is the team uniquely capable to execute the company’s business plan?
- How many employees does the company have?
- What motivates the founders?
- How do you plan to scale the team in the next 12 months?
Ultimately, the investor will need to make a judgment about whether the founder and team will be enjoyable to work with. Does the investor believe in the team? Is the CEO experienced and willing to listen? Is the CEO trustworthy? Also, involving experienced advisors can be very helpful in the early stages to help bridge an early-stage team that is still growing.
2. Is the market opportunity big?
Most investors are looking for businesses that can scale and become meaningful, so make sure you address up front why your business has the potential to become really big. Don’t present any small ideas. If the first product or service is small, then perhaps you need to position the company as a “platform” business allowing the creation of multiple products or apps. Investors will want to know the actual addressable market and what percentage of the market you plan to capture over time.
3. What positive early traction has the company achieved?
One of the most important things for investors will be signs of any early traction or customers. A company that has obtained early traction will be more likely to obtain investor financing and with better terms. Examples of early traction can include the following:
- The creation of a beta or minimally viable product
- Initial or pilot customers, especially brand name customers
- Strategic partnerships
- Customer testimonials
- Admission into competitive programs such as Y Combinator or other technology accelerators or incubators
Investors will want to know how the early traction can be accelerated? What has been the principal reason for the traction? How can the company scale this early traction?
Don’t forget to show early buzz or press you have received, especially from prominent websites or publications. Feature the headlines in a slide on your investor pitch deck. List the number of articles and publications mentioning the company.
4. Are the founders passionate, determined, and in it for the long haul?
Many venture capitalists look for passionate and determined founders. Are they individuals who will be dedicated to growing the business and facing the inevitable challenges? Startups are hard, and investors want to know that the founders have the inner drive to get through the highs and lows of the business. Investors want to see genuine commitment to the business.
5. Do the founders understand the financials and key metrics of their business?
Investors look for founders who truly understand the financials and key metrics of their business. You need to show that you have a handle on all of those and that you are able to articulate them coherently.
Here are some key metrics that angel investors will care about:
- Monthly burn rate of the business
- Projected growth in revenues
- Gross margin
- Lifetime value of a customer
- Customer acquisition cost
- Key components of gross revenues and gross expenses
- How long it will take to get the company to profitability
- How much additional capital will need to be raised in the future, and when
- Other key performance indicators of the business (KPIs)
6. Does the investor know the entrepreneur? If not, has the entrepreneur been referred by a trusted colleague?
If the investor already knows and likes the entrepreneur, that is a big advantage. If the entrepreneur doesn’t know the investor, the best way to capture their attention is to get a warm introduction from a trusted colleague: an entrepreneur, a lawyer, an investment banker, another angel investor, or a venture capitalist. Angel investors get inundated with unsolicited executive summaries and pitch decks. Most of the time, those solicitations are ignored unless they are referred from a trustworthy source.
7. Is the initial investor pitch deck professional and interesting?
The first thing the investor will expect is to see a 15-20 page investor pitch deck before taking a meeting. From the pitch deck, the investor hopes to see an interesting business model with committed entrepreneurs and big opportunity. So make sure you have prepared and vetted a great pitch deck. Reviewing other pitch decks and executive summaries can help you improve your own. See A Guide to Investor Pitch Decks for Startup Fundraising.
8. What are the potential risks to the business?
Investors want to understand what risks there might be to the business. They want to understand your thought process and the mitigating precautions you are taking to reduce those risks. There inevitably are risks in any business plan, however, so be prepared to answer these questions thoughtfully:
- What do you see as the principal risks to the business?
- What legal risks do you have? Will the business model comply with applicable laws, including expanding privacy protections?
- What technology risks do you have?
- Do you have any regulatory risks?
- Are there any product liability risks?
- What steps do you anticipate taking to mitigate such risks?
Startups that can show they have reduced or eliminated product, technology, sales, or market risks will have an advantage in fundraising.
9. Why is the company’s product great?
The entrepreneur must clearly articulate what the company’s product or service consists of and why it is unique, so entrepreneurs should expect to get the following questions:
- Why do users care about your product or service?
- What are the major product milestones?
- What are the key differentiated features of your product or service compared to competitors?
- What have you learned from early versions of the product or service?
- What are the two or three key features you plan to add?
- How often do you envision enhancing or updating the product or service?
- Do you have any favorable customer reviews?
10. How will my investment capital be used and what progress will be made with that capital?
Investors will absolutely want to know how their capital will be invested and your proposed burn rate (so that they can understand when you may need the next round of financing). It will also allow the investors to test whether your fundraising plans are reasonable given the capital requirements you will have. And it will allow the investors to see whether your estimate of costs (e.g., for engineering talent, for marketing costs, or office space) is reasonable given their experiences with other companies. Investors want to make sure at minimum that you have capital to meet your next milestone so you can raise more financing.
11. Does the company have differentiated technology?
As many angel investors invest in software, internet, mobile, or other technology companies, an analysis of the startup’s technology or proposed technology is critical. The questions the investors will pursue include:
- How differentiated is the company’s technology?
- What competitive advantages will there be over existing technology?
- How easy will it be to replicate the technology?
- How costly will it be to build the technology into each product?
Related to that, the angel investors will do due diligence on the key intellectual property owned or being developed by the company, such as copyright, patents, trademarks, domain names, etc. Is the intellectual property properly owned by the company, and have all employees and consultants assigned the intellectual property over to the company?
12. Are the company’s financial projections believable and interesting?
If your startup presents investors with projections showing the company will achieve $1 million in revenue in five years, the investors will have little interest. Investors want to invest in a company that can grow significantly and become an exciting business. Alternatively, if you show projections in which the company predicts to be at $500 million in three years, the investors will just think you are unrealistic, especially if you are at zero in revenues today.
Avoid assumptions in your projections that will be difficult to justify, such as how you will get to a 400% growth in revenue with only a 20% growth in operating and marketing costs.
In order to believe your financial projections, investors will want you to articulate the key assumptions you have and convince them those assumptions are reasonable. If you can’t do that, then the investors won’t feel that you have a real handle on the business. Expect that investors will push back on the assumptions and they will want you to have a reasonable, thoughtful response.
13. How will the company market its products or services?
Investors know that building a great product or service is not enough. The company must have the beginnings of a well thought out marketing plan. The marketing questions will include:
- Who is your target market?
- What are the best ways to approach the target market?
- What do you anticipate the customer acquisition costs to be?
- How will you employ social media to attract customers?
- How will you use paid search through Google, Bing, Facebook?
- What PR do you intend to employ?
- How will you make sure that your website is search engine optimized?
- Will you be engaging in content marketing?
- Will you be relying on third-party distribution channels? Are those third parties sufficiently excited and incentivized?
14. What are the specific terms and valuation of the financing round?
Angel investors may ask the following questions about the financing round:
- How much is being raised?
- How much is already committed by investors?
- Are any prior investors participating in the round?
- Is there a well-known investor leading the round?
- Is there a minimum amount of capital being raised before a closing occurs?
Valuation will be an important issue for the investors. If you tell an investor you want a $100 million valuation even though you started the business three weeks ago, or don’t have much traction yet, the conversation will likely end very quickly. Often, it’s best not to discuss valuation in a first call/meeting other than to say you expect to be reasonable on valuation. But the investor also doesn’t want to waste a lot of time on a deal if the valuation expectations are unreasonable or not attractive.
Valuation at an early stage of a company is more of an art than a science. To help bridge the valuation gap for early-stage startups, you often see investors looking for a convertible instrument with customary conversion discounts and valuation caps. These instruments, such as convertible notes and “SAFEs,” have become quite common.
Final Tips for Entrepreneurs Seeking Angel Investors
Here are some concluding tips for entrepreneurs seeking to obtain angel financing for their startup:
- Target angel investors who invest in your location. Some investors will only invest in companies located near them.
- Target angel investors who invest in your space (software, internet, mobile, biotech, cleantech, etc.).
- Have a great 15-20 page investor pitch deck.
- Practice your pitch and get feedback. Be prepared to have pitch meetings through Zoom or other video platforms.
- Do a product demonstration or have a well-produced video prepared.
- Make sure you have researched the competition and anticipate the questions you may get about competitors.
- Show the investor that there is an opportunity for a big exit (M&A or IPO) in three to seven years.