Whether you are seeking funding to grow your business or not, startups and high-growth businesses can learn a lot from angel investors. If you pitch to them but get turned down, you can learn from their feedback which will be really valuable in helping you think about what changes you need to make to meet your funding goals.
Angel investors are individuals that are willing to invest their own money to fund new startups. Most of them have made money with startups and have succeeded. Read on to learn what startups can learn from angel investors.
Not All Good Businesses are Good Investments
A common misconception is that angel investors invest in startups that will become strong, independent businesses. However, angel investors do not make money from their investment until they can sell their ownership for actual money – until an exit, such as the business being acquired by a larger business or registering for public stock sales. Investing in a startup that becomes a healthy small business, generating its own cash and profits, can be a loss for investors.
There is no return if that business never gives the investors a way to sell their ownership for actual money. No matter how good your business is, if it does not offer cash out for the investors at some point, it is a bad investment.
If the investors end up with a minority share in a healthy business, one that never sells out then they never get their money back. If your business has the potential to start, grow, and be healthy without needing investment from outside, you could be better off without investors.
Keep in mind that when you take investment, you are giving the investor ownership of your business. When they have some stake in the success of your company, they have a vested interest in influencing your day-to-day operations for profitability. Never seek any type of investment when you do not need it.
Do Not Focus on the Numbers
Real businesses turn out net profits in single digits and only rarely up as high as 20 percent. Angel investors are not impressed by projections of 3040, 50 percent or more profits on sales. They do not think that mean you will be profitable, but you do not understand what you will need to spend. If your sales forecast is reasonable, then you are probably underestimating expenses, costs, or both, in your expense forecast, budget, or projected profit and loss.
A lot of angels in the tech business markets prefer high growth and deficit spending to profits. Many investors believe the startups have to choose between profits or growth and cannot do both at the same time.
Big market numbers can work against you depending on the context. Not that bigger markets are not everyone’s goal but because the market numbers can work against you. Angel investors hate projections of sales based on some small percentage of a huge market.
Learn to Scale Up
Good investments need growth, and growth requires what investors refer to as being “scalable”. Scalable means a business can ramp up, increase its volume without increasing its fixed costs proportionately.
Investors use the term “body shop” which refers to the many service businesses that depend on people doing specific things for each unit of sales. Professional services such as attorneys, accountants, consultants, and design or product development companies are classic body shop businesses that cannot scale.
Defending Your Business Against Competition
Angels want you to have a way to defend your business against competitors. They will aske if you have something that sets you apart from the competition. Barriers to entry is what they care about. Sometimes this involves discussing patents. Patents can protect inventions, formulas algorithms. In the real world, patents are always an advantage, patents alone are not enough.
Investors look for what the patents cover, and ways competitors will work their way around them. Not all patents are enforceable and not all parents rule out ways to work around them, getting to the same market without violating the patents.
Other factors that make startups more defensible are trade secrets, effective branding, differential, and first-mover advantage. Investors do not want to identify a great market without having the resources to grow fast and seize market share before others do.
Rapid Growth Costs Money
Angel investors want companies that grow fast and exit. Companies that grow fast are going to present both the need for more investment and the growth potential to justify more investment. Companies that can fund their own growth are less interesting than companies that need to raise more money later to financing continuing growth.
The Bottom Line
If you are working a startup and dealing with angel investors, it is not up to them to understand your story and believe in you. It is up to you to have something they want to invest in.