So, you have come up with a great business idea, found lawyers and incorporated your company, started development in your basement or garage (or located physical space if your business is a restaurant or storefront), maybe have hired some first employees or sold them on a compelling enough vision that they have been working for free and, most importantly, you have burnt through all of the money that you can afford to lose, and maybe even more. Some entrepreneurs have enough cash from prior wins, inheritance, or a quickly cash-flow-positive business model to never have to take money from others. But most are not that lucky. And to whom do most entrepreneurs turn for their next infusion of capital? Angel investors.

What is an Angel investor?

Angel investors are wealthy individuals who are willing to invest in private companies. Angel investors need to be wealthy because private companies are extremely risky investments and as many as nine out of 10 private companies will fail before providing any return to the angel investors. Furthermore, the one out of 10 that does succeed, hopefully in a large way, may take several years to get to an acquisition or an initial public offering stage, and there really aren’t any liquid secondary markets for most private company shares (the shares of so-called “unicorns” such as Uber and Airbnb being notable exceptions). Angel investors are in it for the long haul and need to have the financial ability to take a complete loss on most, if not all, of their private company investments.

Angel investors also need to be wealthy from a regulatory standpoint. The United States government in the 1930s enacted most of the securities laws that we still have today. Those laws require heavy regulatory reporting by companies that sell shares to the public, which is time-consuming and expensive. Small companies can’t afford this reporting and, fortunately, Congress allowed an exemption to this reporting if you sell only to “accredited investors,” that is, wealthy individuals. The current “accredited investor” requirement for an individual is that the individual has a net worth of $1,000,000 or more, excluding the value of the investor’s primary residence, or has had income of at $200,000 in each of the last two years and reasonably expects to have income of at least $200,000 in the current year. This income requirement is increased to $300,000 for joint-tax filers. If you are raising money from angels, make certain that they are accredited investors because it will minimize headaches down the road.

Why do angel investors invest?

As discussed in the last section, most angel investments fail and most angel investors lose money. So why do angel investors invest? In contrast to venture capitalists, who need to make money because being a venture capitalist is their full-time job and the institutional investors who provide them with capital expect to make a reasonable return, angel investors want to make money but don’t necessarily need to. Angel investors invest for several reasons, including the desire to advance technologies and industries for which they have passion and where they might have initially made their money, the general desire to “give back” to the entrepreneurial community that might have helped them earlier in their own career, or simply because angel investing is fun. Of course, if angel investors lose money on every deal they do, they probably will not find it fun and will eventually give up, but as long as they occasionally get a win and it doesn’t hurt them too badly financially, angel investors will usually keep coming back. It is very similar to my golf game; I may play horribly for 17 holes, but if I hit one good shot on 18, I will keep coming back. In angel investing, as in golf, one winning shot can offset a lot of losers.

Which type of angel investor is right for your business?

Angel investors come in several  flavors,  and which type you will be able to attract will depend on a number of factors including how far along your business is, its “stage,” and how inherently credible you are as an entrepreneur. If you are a serially successful entrepreneur who has built and exited many businesses, you might be able to jump right to well-known, professional angels or even to venture capitalists. But most entrepreneurs will probably need to work their way up the angel investor food chain.

Angels you know - friends and family

I often like to separate angel investors into two groups, those you already know and those you don’t know. Odds are, angels whom  you  know are more likely to make a “team bet” on you than angels whom you don’t know (if people that you know won’t bet on you, you might not want to start a business). Angels whom you know are often referred to as “friends and family,” and friends and family are usually the first outside investors in most businesses. When I had my first business during the first Internet boom of the 1990s, my mother invested in it. She didn’t do it because she believed that the world needed a new hip-hop music site (it didn’t), she did it because she loved me (and despite my losing her money on that one, I think she still does). Always remember that friends and family are betting on you, so make sure you treat them fairly.

The advantage of raising money from friends and family is that because they are generally investing solely because of their relationship  with you, they are willing to invest earlier in the company’s lifecycle and before you have hit many milestones, such as actual customers or even a built product. The disadvantage of friends and family is that they usually aren’t high “value- add” in that your average person doesn’t have substantial experience in either private company investing or running early-stage businesses.

Which brings us to angels you don’t know.

Angels you don't know - the benefits of value-add investors

So, now that you have gotten past the friends and family stage and have generated some traction on your business plan, whether that is having customers, signed business deals with partners, advanced product development or patents, or whatever constitutes real milestones in your type of business, it is time to approach investors you don’t know.

Given a choice, at every stage of your company’s development, you want to select investors who are extremely “value-add.” What I mean by value-add is that they will provide not just money but also advice, introductions to customers, acquirers, service providers, and other investors, whether these are other angels, venture capitalists, or private equity firms. Over the years, I have helped my companies negotiate licensing deals with patent trolls, raise hundreds   of millions of dollars in venture funding, sell to larger companies for anywhere from a few million dollars to a billion dollars, and go public through initial public offerings. Value-add investors are willing to roll up their sleeves and help you get what you need to get done, done.

The best thing about investors you don’t know is that they are more likely to be value-add than your friends and family. That is because there are a lot more of them and you can be more selective in which ones you approach regarding your business. As mentioned earlier, one of the reasons angel investors invest is to advance technologies and businesses that are important to them. This also tends to lead them to invest in businesses and industries that they understand. Which is good news for you because that aligns with what you want in an investor: someone who understands the space and customers that you are targeting and can be value-add.

Of course, when you are assembling your angel investor syndicate, you want to make certain that you have a diverse group of investors/advisers in your corner. Having 10 experts in social media marketing may be very helpful for your social media marketing, but having 10 diverse experts would be even better. A great angel investor syndicate brings more than money; they become free advisers for you and the business and they even pay for the opportunity!

The dead lead - the most important person in your angel financing world

Raising money from angels whom you don’t personally know can be very difficult or it can be very easy. How difficult is often determined by the credibility of your “deal lead.” Being a deal lead is somewhat of an informal role, but it is a very important one. A deal lead might be an angel that is investing a substantial amount of money in your financing round, so other investors view them as highly “bought-in.” However, they also can be influential to other potential investors, even if not highly bought-in, because of their reputation as successful investors in similar deals or based on their expertise in the type of business that you are building.

Deal leads have several tasks. They conduct due diligence on the company, including the management team, the market opportunity, the competitive environment, the go-to-market strategy, the viability of the business model, and the potential for a successful financial outcome. They negotiate the term sheet with you, including the financial and control terms of the deal, they shepherd the deal through the closing process, and most importantly, they help sell other investors on the deal. A great deal lead can make the entire financing process extremely easy for you. Poor deal leads may actually make it more difficult to raise your round, especially if they require unusual deal terms (either favorable or unfavorable to you, a topic for another chapter but a red flag either way) or if they are viewed as not credible because of a poor reputation from other deals.

Most angel rounds, beyond friends and family rounds, usually also require that the angel investor group has the right to a seat on your board of directors. Because the board of directors is responsible for the long-term strategy of the company, including having the ability to fire you, you want to make sure you assemble as strong and helpful a board of directors as possible. Since the deal lead will usually end up filling this role, you want to make certain that you choose them wisely.

Where do you find angel investors?

Now that you know that you are looking for value-add investors and a strong deal lead to shepherd them, where do you begin to look for them? The good news is that they generally are not that difficult to find and the best ones want    to be found. For example, here in Seattle, our  local technology blog, Geekwire (www.geekwire. com), writes articles about all of the local financings and the angels who have invested. The most active and influential Seattle angels number only about 15 or 20 or so, and from the deal news in Geekwire and other publications like the business section of The Seattle Times, all of them can be easily identified. But, because the most active angels are often inundated with deals, you generally don’t want to reach out cold to them but rather want to be referred by someone that the angel already knows and trusts.

Some of the best referrals I receive are from the securities lawyers in town. My assumption is that if you were impressive and convincing enough   to have a lawyer whom I respect sign you on as a client, you are worth my taking a meeting with you. The best lawyers recognize that they are making an investment by taking you on rather than another client, so I can effectively piggyback on their due diligence. You still are going to have to convince me that it is worth my digging in further, but at least you will have gotten through the door. Referrals from other professionals such as accountants, bankers, and of course other angels, particularly ones with whom I have invested before, also carry a lot of weight.

Another good target for finding angel investors are the local angel investor groups in your area. In Seattle, these include the Alliance of Angels (www.allianceofangels.com) and the Puget Sound Venture Club (www.pugetsoundvc.com), but pretty much every part of the country now has some local or regional angel investor group. Although most angel investor groups, similar to most angels, invest primarily or exclusively in their own geographic region, some of the groups have more industry-specific focuses and may even invest nationally or internationally. A good resource to locate these groups is the Angel Capital Association (www.angelcapitalassociation.org), which is the official industry alliance of the 100 largest angel groups in the United States.

Angel “newbies” can be good targets if they are experts in something that other angels lack. For example, if I am creating a new restaurant concept and there is a very successful restaurateur in town whose advice would be beneficial, it would be great to get this person into the investor syndicate rather than on an advisory board. People tend to value things they pay for more than things that they receive for free, so getting someone bought-in to your success will usually yield better results than handing out free equity or options to advisers. And it costs you less.

Finally, there are websites like AngelList (www. angel.co) that, if you meet their criteria, can help you connect with relevant angel investors. AngelList focuses solely on technology and technology-enabled businesses, but is worth taking a look if you qualify.

Now that you have your angel investors identified, what's next?

This chapter has focused primarily on the process of identifying the best angel investors for your business. Once these investors have been identified, you will need to sell them on why this venture is one that warrants their capital and their time. Most angels will require an in-person meeting where you will walk them through a pitch deck that shows a large market opportunity, a product offering that solves a real customer problem, a sustainable competitive advantage, an impressive team, a go-to-market strategy that is believable, and a revenue model that makes sense. But some might invest primarily because of the quality of your lead investor and their due diligence and not require any meetings at all. Fundraising efforts can be very easy or very difficult, but by carefully targeting the right angel investors for your business early in the process, particularly your deal lead, you will make the fundraising process more efficient and should find the best investors and advisers to take your business to the next level.

Geoff Entress, Cofounder and Managing Director, Pioneer Square Labs