Wealthy individuals who invest in startup companies are called “angel” investors. The problem with this angelic term is the tendency for first-time entrepreneurs to assume that wealthy angels are warm-hearted and will rescue entrepreneurs and small business owners from the perils of a cash crisis.
The truth is that angels, especially members of angel investment clubs, are demanding. They set high standards and expect entrepreneurs to be “sophisticated” about the fundraising process before making their first pitch for capital.
What do angels want you to know? Here are six recommendations to help you make a good first impression to angel investors:
No. 1: Select the right business structure. Most angel club members prefer to invest in businesses that are organized as standard “C-corporations.” The primary benefit to investors is “C-corps” operate with board of directors' oversight, can issue different classes of stock, and have no limitation on the number of stockholders. In contrast, S-corporations have several restrictions on the size and source of investment activity. Similarly, businesses organized as limited liability companies and partnerships are usually asked to restructure to C-corps before receiving funds from angels and venture capital fund investors.
No. 2: Understand different classes of stock. Most founders of new C-corp businesses receive shares of common stock. Savvy angels, however, usually insist on receiving a separate class of stock, called “preferred stock.” All the terms of a company's preferred stock are negotiable and different investment rounds are likely to give stockholders different advantages over common stockholders. For example, when a company is acquired, all preferred stockholders get paid back their original investment plus some agreed cash premium before common stockholders.
No. 3: Solicit accredited investors. Accredited investors, also known as “qualified investors,” are defined by Regulation D of the 1933 Securities Exchange Act as individuals who have a net worth excluding primary real estate of $1 million or income of at least $200,000 in the two years prior to investment.
New federal securities regulations are expected to require entrepreneurs who raise equity capital from crowdfunding sites to accept checks only from accredited investors. This is a little known gotcha within the crowdfunding community. Entrepreneurs who violate these regulations can hurt their chances of getting funding from angel clubs and venture capital funds in the future.
No. 4: Address investor issues. Nothing makes me wince more than listening to entrepreneurs waste precious presentation time talking about issues that are not top priorities to investors. Yes, its fun to talk about cool features of new websites, games and gadgets but not at the expense of addressing the marketing, partnership and pricing strategies that will make a business successful against its competitors.
Angels want to know how their money will be spent and when a business will reach positive cash flow and profitability. Entrepreneurs who are vague about these issues will lose out to other entrepreneurs who know their numbers, their industry and their game plan.
No. 5: Keep your cool. Potential investors are entitled to ask detailed questions about a business, its managers and its competitors. Entrepreneurs who express frustration with questions or try to rush investor decisions won't like the fast answer they will get in return. Basically, smart angels are intuitive and watchful. They assume that impatient entrepreneurs will eventually turn off potential customers and damage a company's long-term prospects.
Read more: 6 Insider Strategies to Speed Angel Funding
