The Ins and Outs of Angel Funding as a Path for Business Growth

As you prepare to accelerate the growth of your company and expand your geographic footprint, product line or service delivery capability, you should consider all your funding options. While business loans are a common source for this increased need in cash flow, angel funding is another option that many companies pursue.

But is angel investment the right fit for your business? That depends on your cash flow, structure and specific needs.

Angel funding defined

An angel funder invests their money at the early stages of the business, often before products have even hit the market. This is a time when others often aren't prepared to invest. An angel investor usually provides cash in exchange for equity or convertible debt, which is debt that can be converted to equity at a later date.

Most financial angels are accredited investors. As defined by the Securities and Exchange Commission, accredited investors are individuals whose annual income is at least $200,000, or $300,000 jointly with a spouse, or who have a net worth of at least $1 million. Some angel investors end up being directors, partners, board members or executive officers at the companies they help fund.

Pros and cons

Because angel funding is equity—or, in rarer cases, interest-free or deferred debt—you make no payments until your business has the financial strength to do so. That means angel investment comes with a certain peace of mind. If your company fails, the angel investor will only get what the business can provide after paying creditors.

Angel funders who are entrepreneurs, corporate executives or industry specialists can also provide you with invaluable insights, guidance and contacts to help your company grow. And knowing you have someone who believes in you and your business can boost your confidence.

There are also some drawbacks to angel funding to bear in mind. Your angel may become more involved in the business than anticipated. They might oppose your efforts in specific areas or question expenses you want to make, which could derail your plans.

Another potential issue is dilution, which can affect both company founders and investors. As the business grows, an angel's initial investment becomes a smaller percentage of the company's value. This leads many angel investors to seek anti-dilution clauses, which protect their portion of shares. These clauses often have the opposite effect for the founders by decreasing the amount of the company's shares they hold in the long term.

Profit reinvestment

Because of these drawbacks, some startups choose not to seek angel funding. Many founders prefer to maintain more control in shaping the direction of their companies.

An alternative to angel funding is profit reinvestment. This strategy involves ramping up your sales efforts and reducing or managing your costs to generate profits. Then, you invest those funds right back into your company. Those profits help you purchase the assets, hire the personnel or develop the products you need to grow your company. The drawback to this approach is that reinvesting your profits may mean you don't have as much upfront cash to grow other areas of the business.

One variation of profit reinvestment is to require your customers to prepay or make sizable deposits for the products or services they purchase. This can provide you with the upfront cash you need to fund your expansion. Then, you can ramp up sales and manage margins to produce profits that you can funnel back into your business.

When to consider angel funding

If you need funds to create intangible assets, such as software, angel funding may be an optimal solution. It might also be ideal if you need to develop and test a product or to enter an asset-intensive industry. Because angel investment offsets the need for cash flow, you can focus on creating or testing products or meeting customer needs, rather than how you'll pay your bills. However, if you have a service business such as consulting or marketing, consider requiring pre- or partial payment upfront. You could also sell discount service packages in advance of service to get the cash you need.

Many startups seek angel investment to accelerate early expansion. Still, an influx of cash in exchange for equity may not be right for every business. There's no one-size-fits-all solution. Angel investing is another tool in the funding toolkit that you can apply when it makes sense for your particular situation.