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.

How Smart Angels Invest? – A Guide to Creating Your Investment Strategy

Investing in a startup has become more of a trend recently as it promises to return more than what it’s originally worth if it becomes successful. Some of the startups that made it big include Uber, Facebook, and Twitter. If you believe that you have enough capital to invest in the startups, but don’t know how to begin and what strategic direction to choose, it is better to start by analyzing the strategies of smart and successful angels; the type of investments they have in their portfolio and the course of their invested money over a period of time.

It may take some time to master the skills of these angel investors, but don’t get disheartened by it because it will eventually be brought to fruition as you learn to take the right decision. Even the successful investors made plenty of mistakes before they reached this position. Following are some of the things some of the well-known angel investors believe in when they make seed-stage investments.

Investing in People

One of the most famous angel investors of today is Ron Conway, who has made an investment in a number of successful ideas in the past decade. According to him, the most crucial element to consider when you invest in a startup is its team. He said that the idea of an entrepreneur changes and evolve with the passage of time, therefore, it is important to invest in people.

He follows a common strategy called spray and pray by making a large number of small investments. Not every investment made by him guarantees a successful exit, but he certainly has a huge network with different types of investors who look forward to joining the league of these angels.

Capital Efficient Business Idea

Another successful angel investor, Reid Hoffman, who is also a founder of LinkedIn and has made an investment in Flickr, Facebook, etc., believes in innovative ideas that have a tendency to scale efficiently. Whenever he invests in a company, he looks for a product that is unique, has the potential to attract millions of users, and most of all, it can attract funding as a business grows.

Identify the Products that Appeal Consumers

Chris Sacca, an angel investor who has invested in Instagram and Twitter, looks for a product that will be in demand once it hits the market. An example can be his investment in Turntable.fm, in which he invested a lot of time, because he realized it in the beginning that users would become engaged in this investment.

Team Involved in Materializing the Idea

Another well-known name in the angel investors’ community is Chris Dixon, a co-founder of Hunch. He invested in Skype and Milo. Moreover, in 2010, he was ranked number 1 investor in Businessweek. Although, he is always on a hunt for high-tech startups, yet he believes in diversifying away from the risk, and so also invest in startups that do not fall in the category of high-tech. However, apart from the technology, he focuses on the team involved in bringing an idea to reality, and this, he believes, is a crucial part of his investment. He said that as environmental changes occur, the shortcomings in the original idea start popping up. A good entrepreneur would always adjust to the changing environment, which can only be seen through the passion of the team involved.

Reasonable Compensation

Everyone must’ve heard the word PayPal; its co-founder who also invested in Facebook, Yelp, LinkedIn, and Friendster, Peter Thiel, said that he keeps his focus on what a CEO is paid. If these people are being paid a lot of money in the company, the chances of an investment to run out quickly are very high, but if the CEO is paid less than average, it depicts the alignment of his interest with equity shareholders. Therefore, he sees how reasonable a compensation is in the company when he invests.

Provides Solution to the Problem

A famous celebrity, Ashton Kutcher, has only been on the field for four years, yet, he has made substantial investments in high profile companies, such as, Skype, Zaarly, Flipboard, AirBnB, etc.

According to him, what he looks for in a company is the tendency of its product to solve a problem, and the user it engages who demand that solution.

To summarize, whenever you plan to invest in a company, you can choose one or use a blend of these ideas in order to examine factors that may lead to finding a successful deal. All in all, what they focus on is the entrepreneur; the team he assembles, and the idea he represents that determines whether an investment would be profitable or not.

Crowdfunding and Venture Capital

If startups manage to get funding from a venture capital firm (VC) or angel investors, they mark it as a successful milestone.

However, in the past few years, another investment vehicle has been introduced in the financial market to fund innovative ideas called CrowdFunding (CF). It has been changing the game ever since its inception and it is a new form of raising money to finance ideas. Unlike other forms of investments, such as, seed funding, angel investing, VCs or bank loans, CrowdFunding actually enables startups and entrepreneurs to invest in their business with a large amount of capital supply. Before going into detail, let’s look at what crowdfunding actually is.

What is CrowdFunding?

In simple words, CrowdFunding is a mean of raising money through a large amount of individuals, who are requested to fund an idea on a CrowdFunding website with a small amount of money. This phenomenon depicts the wisdom of the crowd, wherein, a business gets an opportunity to satisfy the market demand that was previously not exploited. Having this system in place results in creator getting funds to excel in his creativity and crowd getting a new product, which makes it a win-win situation.

CrowdFunding or Venture Capital – A Better Choice?

This can be a topic of solid debate if discussed in detail, because both sources have their upside and downside. In order to get a clear idea of which one of the two is a better choice, some of the key points have been discussed below.

Ease of Access

There is no doubt that it is easier to access funds via CrowdFunding than it is to raise capital via Venture Capital. You can meet your capital requirement with CF without having to build any connections, and instead, leave the decision to a large group of individuals. Sometimes, VC is hard to access. Despite having actual customers and real revenues, companies are considered small by the venture capitalists.

With CrowdFunding platform, it becomes easier to access a wide array of accredited individuals to fulfill initial capital requirements. On the other hand, regardless of how streamlined the venture capital processes are, there will always be more friction in terms of VC making inquiries and spending more time.

Stability

Stability is a key to a successful business, but it isn’t achieved easily. Most of the startups do not show an incredible growth curve in the beginning. It takes time to find the product/market fit and to find out a scalable way to sell a product. It means startups would need extra time for which, there will be extra financing requirements. In case of CrowdFunding, there is no apparent deal with responsibility and resources to fill this gap. This is where venture capital partners can assist a business to maintain their focus on execution by providing enough cash.

However, it should be done based on TRUST where both the founders of a startup and venture capitalists feel that the investment was done fairly.

Venture Capitalists working with CrowdFunding platforms

Ron Miller, a CEO of StartEngine (CrowdFunding platform), venture capitalists are compelled to use CF, because it asks founders for revealing the strength of their teams and values in the marketplace. He further said that it shows that strong teams and concepts are likely to get exposure in the market, which will draw attention of the VCs and other investors to further invest in their ideas.

For Example, Oculus Rift, a virtual reality system. They raise $2.4 million through CrowdFunding, which gave them the opportunity to rise another round led by Andreeseen Horowitz (VC firm) to raise $75 million.

Both sources of funds have their pros and cons. However, some VCs are now turning to crowdfunding websites to get access to new deals. Having strict timelines, they use CrowdFunding to identify if the idea is worth investing time in.

How to Invest Smarter?

Angel investors and venture capitalists provide funds to early stage or emerging startups in exchange for equity and aiming to make huge profits. The trend of such investments has been increasing and there are a number of startups that became successful as a result of such investments, including WhatsApp, Uber, and Facebook.

It is very important to invest in a promising startup that has a potential to attain a unicorn status, yet, it is not easy to be an investor. Choosing the right start up is as important for an angel investor as it is for an entrepreneur, but does it determine an investor’s success? To understand how one can invest smarter, let’s look at a few tips by different investors.

Focus on Team and Market

The investor in Famo.us, TouchOfModern, and Airseed, Siqi Chen, said that when you make an investment in a startup, it is usually a very early product. Therefore, it is crucial for an investor to calculate and assess the opportunities accordingly and should keep the focus on the team and the overall market.

Ask Yourself – “Would I Join this Start-up?”

Another angel investor, Mike Greenfield, who invested in Hullabalu and Pocket shared some important insights on taking an investment decision. He said that in the beginning, he used to ask himself if the startup would yield a positive outcome on an investment, but it changed over time, and now he usually asks if he could see himself joining that company when he was 24? If the answer to the latter is affirmative, it shows that the founder of a particular start-up is working a problem that isn’t structurally flawed and has a good chance of winning big.

He further said that such companies have a potential to convince a geeky person like him as they work on something that is important and also ace the integrity test. He added that if a startup satisfies all those things, it makes him feel like he’s doing something right as an investor, regardless of whether he makes money out of it or not.

Read the Herd Correctly

There is this common phenomenon in a stock market, whereby, investors can make a lot of money simply by reading the herd correctly. The same was observed by Christopher Schroeder, investor in Vox Media and Skift, when he began angel investing a few years ago. He said that when he presented a deal to bright and successful friends, the first question they asked was “who is in?” even before the question about a team and its concept popped up. Therefore, one has to read his herd correctly before taking any decision.

Identify the Scale of Assistance Required by a Startup

Jeff Miller, another investor in the world of angel investing, said that when an angel provides a feedback on a product, founder usually appreciate it. But the clutch actions are quite rare than anticipated by him. Such actions can affect a company’s future. However, if you look at it from the perspective of successful companies, they look for a minimal assistance from their investors. So, it is important to identify the scale of assistance required by a startup for its future growth.

Choose a Company with a Good Working Product

It is of vital importance to invest in a company that has a good working product. Having a good team of individuals in any startup is not enough if they don’t have a product that solves a problem. A product has to show a “product-market fit.”

Double Down the Investment Once a Potential Unicorn is Spotted

Once you identify a potential winner, you should “double down”, as it represents almost 20 percent of the initial pool of investment.

However, patience is the key, and individuals in early stage startups usually have to wait for 3 to 10 years before they start earning profits from their investment.

Although, there is a lot of risks involved in investing in a new startup, yet the trend for angel investing is rapidly increasing. In order to invest smarter, an investor has to always welcome different ideas, because great ideas are born every day.

But only a few of them, with the right investor (and investment) turns out to be a complete success.

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.