Informal investors, business angels, venture capitalists and private equity firms ... There are different forms of capital to finance risk. But as an entrepreneur, when do you choose an informal investor or a business angel and how do you ensure a successful match? And what is really the difference between these two forms? I have been asked this last question a number of times by innovative entrepreneurs in recent times.
Informal investors versus business angels
How can we actually define informal investors? According to Panteia (2014), informal investors are individuals who use part of their capital to invest in startups or already existing companies, which they themselves do not own.
"An informal investor only counts as a business angel if the company being invested in belongs to an unknown person."
Companies owned by friends, family or colleagues are excluded from this definition. Only a limited group of Dutch informal investors is therefore considered a true business angel. Related to this, you see that in addition to a "bag of money," this so-called business angel often brings knowledge and experience and acts as a sparring partner for the entrepreneur.
How does a business angel decide?
Within Flinc, a qualitative research has been done by a student of the Hanzehogeschool on the matching between innovative entrepreneurs and informal investors. She also reviewed a number of scientific studies on business angels. Among other things, the following emerged.
Two factors dominate a business angel's decision whether or not to invest in an entrepreneur, namely:
- What does the company do in what industry;
- The people behind the company.
Moreover, scientific research shows that the main reasons for funding failure in the top sectors seems to be due to an insufficient substantive match between the company and the business angel, and in the case of SMEs, matching often fails due to agreement on (financial) conditions.
Quality business plan and the entrepreneur(s)
Based on the above factors, it appears that preparation for a "matching process" is very valuable. In our experience, the entrepreneur can prepare for such a trajectory by clearly outlining his plans. Broadly speaking, this should show the following:
- What "problem" does the product or service solve in the marketplace;
- The revenue model underlying this and;
- How to generate monthly recurring revenue (cash flow) to meet financial obligations.
In addition, it is obviously important as an entrepreneur to form a complementary team, both in terms of content and characteristics and skills.
Apart from these perhaps obvious factors, the qualitative research shows that many business angels indicate that a "click" with the entrepreneur(s) is important.
The process leading up to the 'match'
Clearly, matching a business angel and an entrepreneur does not happen overnight. To prevent a matching from failing, much thought must go into the process. This starts with the way business angels are contacted. A number of interviews show that many business angels prefer, how could it be otherwise, an "informal" approach.
Furthermore, it is necessary to identify whether the business angel and the entrepreneur are compatible and/or complementary. The following should be taken into account:
knowledge of and experience in the industry;
- type of entrepreneur;
- the stage the business is in: it is important for an entrepreneur to be able to spar with an investor who has gone through the same stages of a business. For example, building a business from the ground up requires different expertise than taking over a business;
network: it is an advantage if a business angel can provide a suitable strategic cooperation partner or launching customer.
Finally, it is very important for both parties to have broadly clear financial terms and other requirements prior to a "match" in order to increase the success rate.
Conclusion
In my opinion, we may conclude that a business angel can be a very valuable funding tool for innovative entrepreneurs, provided the process is carried out in a careful manner. In addition, practice shows that a decision by a business angel whether or not to finance an entrepreneur is based on a mix of reason versus emotion. Those angels are like people in that respect!