Raising capital is one of the biggest challenges any startup can face, but fortunately, entrepreneurs have more than one option for getting the funding they need. Seeking out angel investors has its advantages, but crowdfunding is redefining how fledgling companies get off the ground. Both have their pros and cons, and it's important to understand how they can impact your startup's long-term outlook before diving in. (For more, see the tutorial: Starting a Small Business.)
Funding a Startup With Angel Investors
The typical angel investor is a high-net-worth individual who has an interest in helping new companies expand. These accredited investors provide startups with seed money in exchange for an equity stake in the company. The idea here is that once the company becomes profitable, the angel investor can sell their shares for a profit.
Angel investors can operate independently or as part of a larger investment group, sometimes known as a syndicate. In terms of how much money angel investors can bring to the table, it's not unusual for a typical investment to range from $25,000 to $100,000. In some instances, angel investors may be willing to part with even larger sums to assist a startup. (For more, read: When Your Business Needs Money: Angel Investors.)
- Angel funding is not a loan. Taking out a small business loan is another way to fund a startup, but it creates a legal obligation to repay what's borrowed. Angel investors, on the other hand, don't expect the money to be repaid. Instead, they're banking on the company increasing in value over time.
- Angel investors can provide more than just money. Angel investors are often established business owners themselves and they have years of experience working with startups. In addition to providing the financial backing you need to get your venture up and running, angel investors will often share their expertise, which can be invaluable to the business's long-term success.
- Angel investors are risk-takers. An unfortunate truth is that the vast majority of startups will fail to become sustainable and from an investor perspective, they're extremely risky. Without a solid track record, obtaining a bank loan or getting funding through a venture capitalist can be all but impossible. Angel investors, on the other hand, understand the implied risks, and they're willing to put their own money on the line to support a startup's growth.
- There may be more pressure to succeed. While the desire to help new businesses succeed plays a part in angel investors' decisions, it's not the only motivator at work. They also want to see their investment pay off in a tangible way. That can turn up the heat on startups to churn out a solid rate of return.
- Angel investors aren't hands-off. As mentioned earlier, angel investors receive a certain amount of equity in exchange for providing funding to a startup. Not only are you handing over a set percentage of the business's future profits but you're also sacrificing a certain amount of control concerning decision-making. That can be problematic if conflicts arise surrounding the angel investor's role in business operations.
Using Crowdfunding to Raise Capital
- Funding doesn't have to be equity-based. While startups can use equity to attract investors through a crowdfunding platform, it's not always necessary to give up any ownership control in the company to raise capital. Some platforms allow you to to use a rewards-based approach to generate funding. For example, if your startup centers on creating a specific product, you may make that product available to your investors before rolling it out the general public.
- Attracting investors may be easier. Bringing angel investors on board can be a time-consuming process because it typically involves pitching your startup's concept multiple times. Crowdfunding platforms, on the other hand, streamline the process by allowing startups to post their pitch in one spot where it can be viewed by a broad range of investors.
- Crowdfunding can increase visibility. Marketing can eat up a large part of any startup's budget but using a crowdfunding platform to raise funds is a low-cost way to spread the word. When a crowdfunding campaign is funded relatively quickly, it sends the message that the startup is one to watch. That can increase the brand's visibility and help to attract additional investors for subsequent funding rounds.
- Fundraising is not unlimited. While $1 million may seem like a substantial amount of money, it may not go very far for some startups. Companies that require more funding may have to turn to angel investors or loans to fill the gap once they've exhausted the crowdfunding cap. (For more on fundraising, see: How to Raise Seed Capital and Grow Your Startup.)
- Fees can be expensive. Crowdfunding platforms are focused on connecting investors with startups, but they're also in business to make money. Startups who use these platforms can expect to pay anywhere from 5% to 10% in fees to raise the money they need, which can detract from the amount of capital they have available.
The Bottom Line
Angel investing is a good option for startups to raise large amounts of capital without being constrained by the requirements that go along with taking out a loan. The main disadvantage, however, is the fact that it requires trading off a certain amount of ownership in the company. While rewards-based crowdfunding offers a work-around to that dilemma, the fees can quickly add up. Weighing the loss of equity against cost can make it easier for startups to decide which option is best.