Is your startup a good candidate for angel investment? If you can’t answer yes to the four questions here, then it probably isn’t.
Angel investors are individuals who invest their money to get a return on their investment. And these four questions solicit your answers on whether your company will deliver a return on investment. Answering yes to all four doesn’t mean you will attract an investor, but even a single no answer means may not.
1. Does your business have an attractive amount of potential growth in sales?
Does your company have a credible growth story? If granted about 60 seconds to do so, could you convince a seasoned investor that your startup could grow its sales from where it is now to $5 million, $10 million or $20 million a year over three to five years?
Numbers aren’t enough. You need a story.
The story should starts with a problem that potential investors can understand, one shared by enough people that your business is tackling an interesting market.
Your business story would then describe the solution offered by your startup, along with details to make it credible such as your qualifications and background.
Investors won’t care about your numbers unless they can already see market potential in your problem and solution.
They’ll take your story and build their own guess about the company’s potential. At that point, the numbers (market analysis, demographics, research) are useful if the story rings true.
And if your numbers don’t match what investors see in their imaginations, then you’ll have to work hard to prove you’re right. If the story works, then numbers are a welcome addition.
2. Can your business be scaled for growth?
Your business would need to be able to increase its unit sales very fast without having a proportionate increase in fixed costs, head count and marketing expenses. Most product businesses can scale larger by adding capacity to a product manufacturing process in a relatively easy fashion. Most web businesses can grow easily since it’s relatively simple to add proper bandwidth when increasing the number of users of a website or application.
Most service businesses can not easily scale for greater growth because they rely on humans, not machines, so it’s not easy to increase capacity without increasing fixed costs and payroll.
One way around this is to pursue franchising. But franchising isn’t credible option for angel investors until you have a very successful working first venue (or two or three).
3. Is your business model defensible?
The founder must be able to explain how he or she will protect the startup from the protential actions of a competitor’s jumping into the market and spending more resources faster, taking over the customers. Intellectual property including copyright, patents and trade secrets – often referred to as the secret sauce – can make a business defensible.
Some great business ideas fall flat with investors because they involve elements that will invite competition and involve no secret sauce to keep larger companies away.
The legend is that the “first mover advantage” makes an idea defensible if the initial entrant to the market grows fast and builds its customer base very quickly. That works sometimes, but not always. Investors will use their own judgment in reviewing the answer, not necessarily what you tell them.
4. Is the management team credible?
Angel investors are not likely to invest in a startup that doesn’t have at least one founder who has already been involved in a startup. This frustrates my email correspondents who complain about the chicken-and-egg problem of having to have received funding before to gain funding. They ask how anybody can obtain experience if angel investors won’t fund their companies.
My answer is that you can gain experience by joining an existing team and spending time with another startup first or by finding co-founders with experience or by changing your business to make it small and focused enough to survive without outside investment.
This is not a problem that most angel investors feel compelled to solve. They are all just individuals not foundations or government entities, so they don’t feel responsible for extending fairness to anonymous hypothetical startups. They just want investments.
So answer yes to all questions or modify for your plan.
Mainstream angel investment isn’t for everybody. Investors become co-owners and potentially bosses – and problematic. Investors might push for an entrepreneur’s exit in three to five years and investors can exercise a lot of power in decisions and limit options.
Furthermore, not being a good candidate for angel investment doesn’t mean your business won't succeed. The vast majority of successful startups make it without angel investment. They use friend and family financing or debt financing. Or they rely on focused business plans that result in growth being financed through sales.