Updated November 18, 2020:

Have you decided that searching for an angel investor is the right way to grow your business? Here's what you need to know to get ready.

Understand the Role of the Angel Investor

Angel investors are individuals who invest in small businesses. In addition to capital, many angels also provide their expertise to help a business grow or expand. This can give a founder additional value over an investor who only puts in money.

Each angel investor operates differently, but you can get a feel for the overall process by looking at how some of the most influential angels operate. Some of the bigger names include the following:

  • Dave McClure, 500 Startups

  • Steven Chen, Independent

  • Joe Lonsdale, Formation8

  • Joshua Schachter, Independent

  • Reid Hoffman, Greylock

The typical angel investment is $25,000 to $100,000, but this can vary based on the investor and your business.

Form a Delaware C Corporation

Forming a Delaware C corporation isn't as hard a rule as it is with venture capital, but here are 16 reasons why many businesses choose a Delaware C Corporation. The C corporation gives you the flexibility to add the angel investor and other potential investors into your capital structure.

Starting in Delaware lets you take advantage of Delaware's favorable laws early on. It also saves you from additional work if you later decide to do an IPO or take on bigger investors who do prefer to invest in Delaware corporations.

Review the SEC Registration Requirements

Most investments by angel investors are private offerings that are exempt from SEC registration requirements. However, you need to be familiar with securities laws and make sure that you are actually exempt. Generally, an angel investor is an accredited investor and exempt if they have a net worth of at least $1 million and make at least $200,000 per year as an individual or $300,000 per year as a married couple.

Of special note are any public announcements that you are looking for investors, especially if they appear on social media or an industry discussion board. These messages must be carefully targeted and crafted to avoid being considered a public offering – in other words, you can’t advertise or solicit investment to the public.

Similarly, you should also check whether your state has any “blue sky” laws that impose separate or additional requirements on investment offerings.

Protect Your Intellectual Property

Virtually all businesses, even the earliest startups, have some form of intellectual property to protect. This can include inventions, secret processes, logos, slogans and other intangible property. You can learn more in-depth through our guide on protecting intellectual property for startups.

Keep in mind these three goals.

  • Ensuring that your previous employer or others who may have been involved in your startup can't claim intellectual property rights.

  • Obtaining patents, trademarks or other legal protections to secure your rights.

  • Avoiding giving up rights when entering into licensing deals, partnerships or cofounder arrangements.

Decide How You'll Raise Funds

You have several options for how you'll raise capital.

  • Equity (selling stock) trades an ownership share of your business for capital.

  • Debt is a loan arrangement that requires fixed payments of principal and interest but preserves ownership shares (you aren’t selling any equity in the company).

  • Venture debt is a debt arrangement where the lender also receives a small permanent equity share in exchange for making the loan. This can be used to lower your interest rate when your business doesn't have established credit, or when you want the investor to remain involved in your business.

  • Convertible debt starts as a loan but converts into equity based on certain predetermined conditions. Convertibles can be used to encourage the lender to take a risk as with venture debt, or they can be used to raise early investments without locking into a specific valuation.

  • Preferred stock is a special class of equity that gives the shareholder preference in dividends and liquidation often in exchange for giving up voting rights. This is useful where investors are asking for equity but you don't want to give up control of your company.

You should also review who you'll raise money from.

  • Angel investor networks: Some angels prefer to operate in networks instead of acting individually. They may pool their money similarly to a venture capital fund. They may also invest as individuals but remain anonymous while allowing the network's advisors to guide the businesses they invest in.

  • Archangels: Archangels are successful angel investors with large capital pools. They generally take the lead in investments but have a team of advisors that helps to select companies and run the day-to-day operations.

  • Fools, friends and family: If you need a small investment just to get started, turning to the people you know may be the most cost and time-effective way to do it.

  • Venture capital: Venture capitalists may be able to provide a larger investment with a structure that might be more favorable than what an angel investor would offer. Many angel investors want to be in control while venture capitalists may be more comfortable letting you remain in charge as long as you pass due diligence and deliver results.

  • Traditional crowdfunding: If you're looking to launch a product, pre-selling on a platform such as Kickstarter or Indiegogo may give you the capital you need without giving up any shares in your business.

  • Equity crowdfunding: This newer form of funding allows you to raise small equity investments from many investors at once. Your securities law compliance requirements will likely be higher but it avoids having to rely on one investor and may build your brand recognition.

Know Your Business Phase

Angel investors as a group are more flexible than venture capitalists about what stage a business should be in to be investable. On the individual level, they still have their preferences.

Some will invest in very early startups while others want a longer track record of sales or previous investments. Additionally, later-stage businesses aren't shut out like with venture capital. Some angels specialize in taking established local businesses to broader markets or reviving struggling businesses.

Know where your business is so you can target angel investors who focus on similar phase businesses.

Prepare Your Presentation

As with other investors, you'll need to be ready to make an impression.

  • Elevator pitches are your initial introduction either as part of a larger pitch or when you're out networking. Keep it short, simple and memorable such as "The Amazon of China" was for Alibaba.

  • The executive summary provides a brief written overview of your business and your plans to grow in one to two pages.

  • Your business plan contains every detail about your business, your plans and your finances.

  • Pitch decks are slideshows that you use when pitching or to mail to potential investors. This is where you add in visuals and focus on telling your story.

Note: You should be prepared for an Angel Investor to push back on signing a non-disclosure agreement. Angel investors hear dozens or hundreds of pitches with potentially similar ideas and don't want to take on any risk of litigation.

Work With Advisors

Even though angel investors are more involved in your business, they can't do everything for you and want to see that your team has the experience to succeed with limited guidance. Whether it's sales, marketing, logistics or something else, establish a team that covers any areas where you aren't an expert.

Your team should also help you decide if a particular angel investment deal is right for you.

Understand the Potential Terms

An angel investor will present a term sheet that covers far more than the amount invested and the ownership share received in return. One of the most common provisions is an anti-dilution clause that keeps the angel's shares from being diluted by additional stock sales. Another is a liquidation provision that gives the angel priority rights to the company's assets in the event it goes out of business.

Other terms might include the following.

Determine Your Valuation and Cap Table

One of the most important things to get right is your initial valuation. Many founders mistakenly value their company on their dreams of being worth tens of millions or more in the future. A more realistic valuation is three to five times revenue with a maximum multiple for a solidly established business at about 10x.

Giving shares at too high a value early on can make it harder to raise later investments. And you don’t want to suffer a “down round” – an investment based on a valuation lower than the valuation in a prior round. Your cap table should show share ownership consistent with this valuation as well as your plan for adding shares for additional investors.

Set a Budget

You should only raise money when you have a clear need. This encourages careful spending, prevents you from diluting your ownership and leaves shares available for when you really need to raise capital.

Decide what you need to move to the next level (e.g., scaling production or expanding marketing), figure out how much that will cost and look to raise only that amount.

Find Success to Build On

Most angel investors look for some sort of indication that you have a business not just an idea. Few will invest in an idea alone unless it's truly novel. Whether it's a successful Kickstarter campaign, early online sales or a contract from a major customer, get something you can point to that proves your idea can work as a business.

Have a Plan to Scale

Angel investors also want to know you have a plan to grow so that their money is put to good use. If your focus for raising investments is marketing spend, you need to have a plan in place to handle an increase in orders.

It's OK to say you're looking for guidance on some of the specific details, but your business plan should lay out the foundation of your strategy.

Plan Your Exit

Many angel investors look to sell after a certain period of time or a certain level of growth. If you're looking to stay in your business for life, you could find yourself at odds with an angel who wants to position you for a sale, or an IPO in five years.

Look for an angel investor whose buy-and-sell timeline or buy-and-hold strategy matches your own goals.

Be Ready for Due Diligence

Once an agreement in principle is reached, the due diligence process begins. This is a thorough review of your financial and business records to verify the information you gave in your pitch.

At the same time, you should also be doing due diligence on your angel investor. Look at their track record with their previous investments to see if the results they delivered match up with why you're asking them to come into your company.

Consider Raising Additional Funds

If all goes well with finding angel investors, you will want to consider how you can raise more seed money and how you can prepare for raising venture capital.

Get a Lawyer

Most founders will want to have an experienced attorney to guide them through the process, finalize the deal, and handle any SEC requirements. UpCounsel provides a pre-screened directory of top startup lawyers in your area who are available on an as-needed basis. Start your search now.