Angel Investors & Friends and Family – The Key Source of Funding

Investing in startups is a challenging task. Some startups make big promises, but end up failing, while others turn out to be quite a success. For example, the early investors of Instagram got more than 300 times return on their initial investment within a period of two years. But these are one of the mega jackpots. On many occasions, investors suffered heavy losses as well. This is the reason why they are wary of investing in startups.

However, it has been observed that the key sources of funding for a startup are either angel investors or their family and friends.

 

Friends and Family as a Key Source of Funding

According to a survey, friends and family invest more than $60 billion every year. Moreover, around 38 percent of the startup owners gather funds from their kith and kin and the average investment value is around $23,000.

There is no better way to raise money than to seek the help of your own family members or friends. They can be an ideal option to give your business a head start. If you have reliable family members who are willing to invest, it can be a valuable resource and a long-term opportunity, especially because their main motivation will be to provide support and show loyalty toward the founder rather than expecting a high return on investment.

It is basically a close circle of those individuals who have a strong affinity with your brand or with you.

However, it is very important that these investments are officially set down in writing. All the documentation should be signed by the investors with their consent to the fact that there is a risk that they might not get their cash back.

 

What is the Risk Involved?

It is crucial to know that business should not be mixed with pleasure. Taking money from friends and family is a huge responsibility and risky at the same time. Make sure you share a strong bond with them so that your goals do not get affected when things go wrong. By accepting the funds provided by the family members or friends to start your business, you risk their money. Therefore, it is of vital importance that all parties come to a consensus before anything is initiated.

To manage and control the risk, every party should sign a promissory note that contains repayment terms. In case, your friends or family members want to partner with you, sign a partnership agreement and keep the official documents with you.

 

Angel Investors as a Key Source of Funding

According to a report, more than 268,000 angel investors are active in the United States. Every year, they make an investment of 20 billion dollars in around 60,000 businesses. The average investment amount is approximately $75,000. As per the Angel Resource Institute database, in 2012, the recorded number of angel groups in the U.S. was 385.

Angel investor is an affluent person who provides funds for startup companies, mostly in exchange for equity ownership or convertible debt instruments. A lot of these individuals are either business professionals, higher-ups in the corporate sector, or renowned entrepreneurs. Similarly, there are angel groups as well that consist of individual angels who come together for a common goal, i.e., to evaluate and fund the startup companies. These groups allow such investors to pool their money and make larger investments.

 

Benefits of Having Angel Investors as a Source of Funding the Business

They are usually the ideal source to fulfill funding requirements, because they are focused on the healthy growth of a startup company. Moreover, they also contribute as a coach or mentor based on their own experiences. For example, angel investors introduce startup founders to prospective investors and potential clients. They also identify the problems, advise solutions, and help these businesses to get recognition and credibility in the market. All in all, angels take a lot more risk as compared to other institutional investors. This is the reason why they are so dedicated and seriously concerned about the profits and losses of their portfolio companies.

 

 

To summarize, there has been a rising trend of getting funds from angel investors or family and friends, as they have not only been beneficial to fuel the startups, but have also contributed toward a better economy around the globe.

Value Investing or Spray and Pray

In my last article I wrote about the value investment strategy, now I will compare it with the “Spray and Pray” method.

Value investing and Spray and Pray are two of the widely talked about strategies in the world of venture capital. Some of them view value investing as a reasonable approach, because it is concentrated toward investing in companies that are undervalued and have a strong business model with good future prospects. While others consider spray and pray method to be a wise approach as they believe it gives rise to diversification and enables investors to generate maximum return out of a few startups that reach a unicorn status. Before going into detail about which strategy is better, let’s take a look at what value investing and spray and pray strategies actually are.

Value Investing

It is a commonly used venture capital strategy, where investors seek the companies that have a potential to produce large profits for an extended period of time. It is a concentrated investment approach that allows VCs to identify good startups after keeping in mind certain factors, including the cash flow position of a company, profit generation from its key operations, and its potential to grow in future.

Spray and Pray Method

Spray and pray method is a more diversified approach and is considered aggressive by some investors. A well-known name in the world of venture capital, Dave McClure, founder of 500 start-ups, is usually known as a spray and pray venture capitalist. However, he detests the idea of being characterized as such. A few years ago, he participated in a panel discussion of angel investors, where he said that he puts a lot of thought into his investment strategies, so it is not fair to call it spray and pray method; it is diversification with a thorough working behind it.

More Concentrated Approach or Diversified Approach – Which is Better?

When it comes to choosing between value investing and spray-and-pray strategies, mixed reviews are received from the market. For example, in an interview with McClure, he argued that a high volume and diversified investment strategies, like spray and pray, provide consistently stronger cash on cash returns than in the case of more concentrated scenario. He supported the idea by explaining his portfolio of 500 startups that around 60 to 80 percent of his investments do not reach any return less than 1x invested, whereas, 15 to 20 percent do provide 3 to 5 times the original investment. Moreover, 5 to 10 percent reach exceed the value of $100 million, but the actual return is generated from 1 to 2 percent of the startups that reach a unicorn status and provide 50 times or more of the originally invested funds.

When we talk about multi-party seed round, investors are compelled to earn their right to participate in the next phase due to the increased level of competition. It not only provides greater value to venture capitalists, but also turns out to be beneficial for entrepreneurs. According to McClure, using spray and pray at the seed level, collecting insight and optionality on early stage startups, and then doubling the bet on the successful investments, can actually break the perception of considering the concentrated portfolio strategy as industry best practice.

Flagship ventures, on the other hand, carefully select later stage value investments. They actively evaluate and fund the companies that are at an advanced stage in a product development, yet, these firms require additional funds and strategic involvement to reach their full potential. In a panel discussion of angel investors, Jed Katz from Javelin Ventures said that they invest as little as a few hundred grands to $2.5 million in the companies and dedicatedly invest the time and energy to expand their scalability. Another venture capitalist, Manu Kumar from K9 Ventures, said that he prefers all his companies to be a success, and this is the reason why he is very cautious about where he should invest. He further said that there are various strategies at a seed level, however, it doesn’t mean that one strategy is right and the other is wrong; they are just suitable at different levels.