An outline of the pros and cons
Early-stage businesses often struggle to secure cost-effective funding, but sometimes funding alone is not enough to help them thrive, especially when expertise is critical to success. A business angel can provide both, and this could be a good solution to explore and consider. But, are business angels truly the answer to your business prayers?
Business angels can offer an attractive combination of affordable financing and business acumen which could accelerate your business. It is important that the advantages should outweigh the disadvantages and the business deal should be appropriately documented for a small business to secure the benefits.
What is a business angel?
Typically, a business angel is a high-net-worth individual who manages a portfolio of investments made in early stage or startup businesses. Funding is offered in exchange for equity in the business and depending on the business angel’s expertise, they may also offer mentoring or access to contacts and opportunities as part of the package.
A business angel can be anyone: family, friend, a business set up to be an angel investor, a celebrity or a patron from a larger organisation.
Advantages of a business angel
Angel investors can offer several notable advantages, namely:
- Pitching opportunities – arguably, pitching to and persuading a business angel to invest in your business could be easier than when seeking other sources of funding like a bank loan. The angels are used to assessing investment risk and therefore less likely to be risk averse. They will also have the experience of knowing which sectors and types of businesses they are likely to get a good return from, and so getting a successful investment from an angel could give you and your business a confidence boost.
- Interest and repayment free investment – depending on what is negotiated, it is usual that investment from a business angel will not require interest payments to be made and should the business fail to be successful, the investor’s money (unless secured) may not need to be repaid (unlike a bank loan). This is undoubtedly a significant benefit for a small business.
- Added value – the knowledge, insights, access to resources and contacts that a business angel can offer could mean the difference between your business making small inroads and being able to take huge leaps.
- Choice – in the digital era we live in, accessing and being in a position to choose the right business angel is so much easier. You are not limited to your geographical location or just having one. You can take your time to find the person who is the right fit for your business.
Disadvantages of using a business angel
The advantages can seem so attractive that it is easy to ignore any pitfalls associated with seeking funding through an angel investor. However, there are several disadvantages that you should consider, including:
- Equity transfer – the price of any angel investment means giving up equity in your business, typically at a minimum of 10 per cent, but they may use their leverage to increase this up to 50 per cent. When giving up any equity, it is always important to consider how your business may look in the future. What if you need to take on more investors? How will the dilution look then? Are the investors asking for special terms that could compromise your voting or preferential rights? Are they asking for restrictions on future investment, making it less appealing to future investors?
- Management of business – depending on the equity stake the business angel takes on, the business angel could end up getting more involved in the day-to-day running of the business than you had anticipated or indeed desired. Their involvement and remit should be discussed and documented in detail.
Consequences of relationship breakdown – if the relationship breaks down and the angel investor has a significant share of the equity, it increases the chances of them exercising rights over a change of management and even, in the worst case, ousting you.
Key issues to tie up in your documentation
Any commercial agreement you reach will need careful documentation to ensure there is a balance in bargaining powers. Among other requirements, you will need to amend your shareholder agreement, update your corporate filing and enter into an investment agreement.
A few (not exhaustive) key issues that will need consideration and negotiation may include:
- Buy back options – these leave the door open for you to buy back equity in the future, if the investor is agreeable to the same.
- Exit strategy – it is advisable to ensure all parties are on the same page regarding exit strategies, consents, vetoes. Any attempt to force you into an early sale of the business in the event of underperformance should be restricted as much as possible. On the other hand, looking at your options around how to terminate the investment agreement (should you need to) and the impact termination could have on the shareholding will be another critical aspect that you should seek professional legal advice on.
- Performance targets – the business angel will stipulate strict commercial terms including their expectations for growth and triggers if those targets are not met. Any due diligence and analysis work you can do before entering into any agreements would be well advised. That way, you will have a better idea whether you will be able to meet the targets. Considering all the assumptions and stress factors that could impact those targets will be crucial too.
How we can help
We have a strong team of experts across corporate, commercial and financing which will allow us to deliver you streamlined, comprehensive advice on how to work with your chosen business angel successfully.
For an informal discussion, please contact Olivia Chalmers in the corporate and commercial team on 01733 882800 or email [email protected].
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