Is your startup a good candidate for angel investment? If you can’t answer “yes” to the four questions here, then it probably isn’t.
Angel investors are as hard to predict as any other group of individuals, all operating in their own self interest. There are about a quarter of a million angel investors in the U.S., according to most estimates. But they are not an organized group, and not a public entity. They invest their own money and they normally want a return on their investment. They tend to invest in startups close to where they live, and in industries they know.
Still, there are some predictable factors that will make some startups good candidates for angel investors, and others not. There are many special cases, but in general, you need to be able to say yes to the four questions or you are not likely to get angel investment.
Do you have a credible growth story? Given about 60 seconds to do it, could you convince a seasoned investor that your startup can grow its sales from where it is now to $5 million, $10 million, or $20 or more millions per year in 3-5 years?
Numbers aren’t enough; you need the story. The story starts with a problem potential investors can understand, one shared by enough people to make an interesting market. It then describes the solution your startup offers, along with details to make that credible such as your startup’s qualifications and background. Investors won’t care about your numbers unless they already see market potential in your problem and solution. They’ll take your story and build their own guess about potential. At that point, numbers – market analysis, demographics, research – are useful if the story rings true. And if your numbers don’t match what investors see in their imaginations, then you’ll have to work hard to prove you’re right. If the story works, then numbers are a welcome addition.
Scalable means that a business can increase unit sales very fast without having a proportionate increase in fixed costs, headcount, and marketing expenses. Most product businesses are scalable because it’s relatively easy to add capacity to a product manufacturing process. Most web businesses are scalable because it’s relatively easy to add hosting bandwidth to increase users of the same site or application. Most service businesses are not scalable because services are provided by humans, not machines, so it’s not easy to increase capacity without increasing fixed costs and payroll.
One way around this is franchising, which supposedly duplicates a service formula to offer the equivalent of scalability. However, franchising isn’t credible, in angel investor terms, until you have a very successful working first location (or two or three).
Defensible means a startup can protect itself from a competitor jumping into its market and spending more resources faster than your startup, taking a market over. Intellectual property including copyright, patents, and trade secrets make a business defensible. This is often called the secret sauce.
Some otherwise great ideas fall flat with investors because they are something that will invite competition and involves no secret sauce to keep larger companies away.
The legend is that the so-called “first mover advantage” makes an idea defensible if the first mover grows fast and builds its market very quickly. That works sometimes, but not always. Investors will use their own judgment on that one, not necessarily what you tell them.
Angel investors are not likely to invest in any startup that doesn’t have at least one founder who has already been involved in a startup. This frustrates many of my email correspondents who complain about the chicken-and-egg problem of having to have been funded before to get funded; they ask how anybody gets experience if angels won’t fund them. My answer is that you have to get experience by joining an existing team and spending time with a startup first, or by finding co-founders with experience, or by changing your startup to make it small and focused enough to survive without outside investment.
This is not a problem that angel investors feel compelled to solve. They are all just individuals, not foundations or government entities, so they don’t feel responsible for fairness to anonymous hypothetical startups. They just want investments.
Yes, there are always special cases and exceptions. But the executive summary is that if your startup can’t meet these four essential conditions, you should be either scaling down your plan to cut expenses so low you don’t need investment; or looking for alternative sources, such as friends and family.