Before any company can set out to raise investment capital from anyone, including angel investors, it first needs to understand the type of company it is, the capital landscape it is operating in, and who it is trying to raise capital from.
I like to divide newly created companies into two categories: Startups and Small Businesses. While all newly created companies are technically small businesses, I will explain my categorization further.
Startups Vs. Small Business
What is a Small Business?
I define small businesses are local or regional organizations solving a local need. This type of business does not need to be unique from competitors, is not necessarily targeting a large global market, and is not looking to scale rapidly over the next 3-5 years. It is typically owner operated, and is not planning to raise considerable capital over multiple rounds and is therefore not planning an ‘exit’ for its investors in 5-7 years by selling itself to another company or going public on a stock market.
What is a Startup?
Conversely, I define a startup as a business looking to solve a large or global problem. As part of that, the startup is looking to tackle a large market, typically over $1Bn, and will need to scale rapidly over the next 5 years in order to gain market share and outpace competitors. Startups typically have a technology component that helps them scale quickly, and often need a unique factor or offering that differentiates them from competitors. To achieve this growth and scale, startup founders are willing to provide extreme dedication to their business, but at the same time, are willing to dilute their ownership by allowing in a series of external investors over a number of rounds. These capital raises will culminate in a clearly defined ‘exit’ for the investors, typically either with the startup being acquired by a large corporation, or through an Initial Public Offering on a stock market, taking the startup public.
As a founder considering raising capital, it is important to take a hard look at yourself and your business, and decide which category (small business or startup) you feel you belong to. Why is this meaningful? The tough reality is that most investors in early stage companies, whether that be Angel investors or Venture Capitalists, are only interested in investing in Startups, not small businesses.
Once you have confirmed that you identify your business as a ‘startup’, the next critical step is to understand the ‘stage’ of your business in the startup capital raise lifecycle.
Startup ecosystems around the world have slowly started to standardize somewhat the amount, type, and style of a capital raise for a company with that company’s specific stage of growth and entry into the market. Understand this can help you as a founder match the amount of capital you are looking to raise, and who you are looking to raise it from, with the current stage and growth progress of your business. It is critical to understand that startup ecosystems around the world are different, as are investors. While the labels for company stages are the same, expected valuations and raise amounts can differ quite drastically from country to country. The largest raises and highest valuations can typically be founding Silicon Valley in the USA, which also happens to be where most of the startup educational content comes from. I caution founders to understand the differences between their home market and Silicon Valley, and not to expect Silicon Valley valuations or raise amounts when speaking with investors local to them.
This article is being written by me, a Canadian, and will provide rough numbers based on the Canadian funding landscape and in Canadian dollars. Please note any raise amounts or valuation ranges provide are extremely rough and many not be applicable to your unique situation.
We can break the stages down as follows:
Ideation (Bootstrap/Family & Friends Round)
You have just thought of your business idea. You may have a pitch deck for it, but you have just incorporated the business and have not yet actually created any physical product, good, or service that you will sell to customers. You are continuing to work on actually creating the basis of what will become your company.
- Early stage, No Minimum Viable product
- Raising capital to build product
- Typically raising $100,000-$200,000
- Family & Friends round, or bootstrap
- Too early for Angel Investors
- Typical valuation for a startup at this stage is $1MM
At the ideation stage, there are almost no individuals willing to invest in your business. This is because of the considerable risk in such an early investment. Without you having made anything yet, the investor is providing you money not only on the hope that your product will be well received in the market and will sell, but that you will be the right person to even create this product I the first place. For this reason, typically founders at this stage will either need to bootstrap (self fund) the business, or raise a small investor from Family, Friends, and Close Business Associates. Basically, individuals who know you well as a person, and are willing to take a bet on you that you are the right person to actually build this product. Unless investors already know you personally quite well, they are unlikely to participate at this stage.
Beta Stage (Pre-Seed Round)
The next stage is the Beta Stage. The Beta stage is one step beyond the Ideation stage. You have started created a prototype of your first product or service. Now that the company has started actually creating something, there is a better chance to raise capital from external investors. If a company chooses to raise capital at this stage, this would typically be called a ‘Pre-Seed’ Round.
- Mid prototype development
- Pre go to market
- Pre-Seed Round
- Funds used to complete MVP
- Raising between $300,000 – $500,000
- Startups at this stage typically see valuations around $3-5MM (subject to market conditions)
- Angel Investors, Equity Crowdfunding, Friends & Family, Incubators, Government Grants
The capital raised during this round should be used to help move your beta product into a minimum viable product, or MVP, which you can begin to show customers. At Beta stage, it is also recommended to begin collecting a waitlist of potential future customers interested in trying your product once it launches. Investors who participate at the Pre-seed stage are Angel Investors, Equity crowdfunding investors, incubators, and government grants. Please note that with the recent economic downturn, more Canadian angel investors
have started wanting to see companies with revenue, and have been less willing to hear pitches from pre-revenue companies.
MVP Stage (Seed Round)
The stage following Beta is Minimum Viable Product (MVP) stage. At MVP, the company should have a fully functioning minimum viable product that they can begin taking to market and providing to customers. The company should also have a strong list of potential clients and people on their waitlist. Sales at this stage is a positive but not required. Capital raised at the MVP stage is called a Seed round.
- Completed MVP
- Gather list of potential sales
- Revenue is a positive but not required
- Seed Round
- Angel Investors, Equity crowdfunding, Early Stage Venture Capital Funds
- Raising between $500,000 and $1,000,000
- Startups at this stage typically see valuations around $5-10MM (subject to market conditions)
- Capital raised is to go to market and beginning testing the fit of the product with customers, tracking demand
Investors who typically participate in seed rounds are Angel investors, Equity crowdfunding platforms, and Seed stage venture capital firms. As previously noted, given the recent economic downturn, angel investors have been less willing to invest in pre-revenue companies. Capital raised during a Seed round is typically used to take the product to market and begin testing product market fit.
After the MVP stage comes the ‘Product Market Fit’ (PMF) stage. During this stage, companies are focused on confirming that the product and business model they have developed is well received by the market, and they are able to begin driving more sales. This stage may involve pivots to adjust the product to market demand and reception. Capital rounds at this stage are often referred to as a ‘Series A’ round. Companies are typically raising between $1MM-$3MM at valuations between $10-$20MM. Rounds at this stage are typically dominated by Venture Capital firms, and are typically too large for angel investors. Companies can still raise via equity crowdfunding at this stage, and angels who might participate typically do so through a platform at this point.
The final stage before exit is growth/scale stage. At this stage, companies are already sizable and have confirmed there is clear demand for their product/service at the pricing model they have chosen. The companies goal now is simply to expand and gather more market share as they get larger. Rounds raised at this stage are called Series B, C, D, etc. These rounds help fuel the growth of a company as the move towards a final exit. Participants at this stage are late stage Venture Capital firms and Private Equity companies.
Understand your Stage
It is critical for companies to understand their current stage as well as their trajectory to understand the expectations investors might have for them. Are you raising a larger amount at an earlier stage and is expected, it might be worth reconsidering your raise amount and splitting it into multiple smaller rounds. Are you reaching out to VCs at the Ideation or Beta stage? You are probably to early for them, and may be using up valuable resources chasing the wrong investors.
What is an Angel Investor?
Now that you understand your business and stage, you can turn your attention to understanding who you are actually asking for money. Not all investors are the same, and investors are often unique individuals just like us. For that reason, it behooves founders to take the time to understand their investors to better address their needs and find a great fit.
So what is an Angel investor? An Angel investor is someone who chooses to invest into early stage companies like startups. They are called Angels because they typically invest at an earlier stage than other investors, and help companies get the capital they need to grow.
To be an Angel, the individual must qualify as an Accredited Investor. Typically, an individual qualifies as an Accredited Investor by having either $200,000 or more in personal annual income ($300,000 with a spouse) or over $1,000,000 in Net financial Assets (excluding real estate). See here for a full breakdown of all ways people can qualify as an Accredited Investor.
There is no certification or anything provided to individuals who are accredited Investors. It is simply a legal definition based on their personal financial situation. Not all accredited Investors chose to invest into early stage companies like startups, but those that do are often referred to as Angels.
Angel Investors are People too
Focusing on Angel investors, it is important to understand the difference between different individuals. Just like us regular folk, angel investors are unique individuals are all act, research, and invest in companies differently based on their own goals, desires, and personal experiences. Some Angels have participated in many investments and have considerable experience, while others are new Angels and have never made an investment before. Some angels may choose to focus on investing in industries or areas in which the Angel has previous experience, perhaps from their career. Angels will focus their investments based on their own investment hypothesis, which can include a focus on industry, company stage, B2B vs. B2C, their minimum check size, etc.
Given this variability, it's important to understand the goals and objectives of the angel investor you are speaking to – to ensure there is a fit between your raise and their goals. Understanding early on if an angel only invests into B2B (business to business) SaaS (software as a service) companies is helpful if you are running a B2C (business to consumer) product company.
You will also see these differences play out when it comes to due diligence, investment size, and whether the angel is willing to be a lead investor.
Even with the variability present between different angels, there are some standard expectations that companies should have with regards to the stage that most Angels invest at, and the minimum amount each angel might invest.
Typically, angel investors invest in pre-seed and seed rounds, and the minimum check size (minimum investment amount per investor) is often $25,000. It is important to understand if the angel you are speaking to is investing as part of an Angel group, or on their own.
An Angel group or syndicate is a group of angels that meet together and typically invest together. They will often focus on investing in deals connected to their local geography. Angel groups can make it easier for Angels to get good deal flow (access to new investment opportunities) and benefit from shared due diligence.
Typically Angel groups will have standardized expectations when it comes to reviewing deals, certainly in Canada. Most Angel groups in Canada will look at companies at the pre-seed or seed stage, and as such, will only be interested in companies with a $10MM valuation or less.
Angel groups typically meet once a month to review deals, and companies must be approved by the angel group in order to pitch at the meeting. Angel groups typically take one month off over the summer, and may take December off as well. Typically the group will meet in person, and allow 2-4 companies to pitch at each meeting. It can take 1-2 months before you are approved to pitch at a meeting.
When founders are pitching an Angel group, it's important to note it does not guarantee the investment of each investor in the group. The angels will still choose to invest individually, so even if one investor chooses to participate, it does not mean the whole group participates.
If angel investors are interested after your pitch, the interested angels will request additional meetings, and will likely ask for more information to complete due diligence. Due diligence can take 1-2 months before the actual investment documents are signed and you get the funds.
Sometimes, new angels will join Angel groups in order to learn more about Angel investing and to learn the process. Often there will be several key individuals in an Angel group that other members will look to for guidance, so these individuals may be key to get onboard if you want to have strong participation from the Angel group.
Whether receiving investment directly from individual angels or through Angels in an angel group, it is important to understand the role of the ‘lead’ investor.
The lead investor is the investor who decides to take on the work of completing the due diligence into your company, and for setting the terms of your investment round (based on that due diligence). Often, newer angels will wait to see if you have a lead investor, and will want to have their investment follow along behind the investment of a knowledgeable lead.
In certain situations, other organizations can act as the lead, and complete due diligence on the company and structure the round. Equivesto (my company) is a licensed exempt market dealer and online platform, and often completes due diligence and structuring work for companies that want to raise on the platform.
For later rounds, experienced Venture Capital firms will often act as the leads investor, and many other VC firms and investors will fight to join round led by famous or well reputed lead investors.
Angel Investors expectations
With the current economic trends, there have been some changes in Angel expectations. More and more Angels are now expecting to see companies post revenue to consider them for funding. For several years, Canadian angel groups would only allow companies to pitch with a valuation of $3MM or lower. More recently that has moved higher to $5MM, and its now between $5-8MM.
Even with those increases in valuation, founders need to be aware of the change in expectations and negotiating position with Angels since the downturn in the markets. It is no longer a hot startup market, where exciting companies could set the terms and investors would have to work hard to be included. Since that change, the negotiating power has returned to the investors, who are more conservative and looking for terms that are more in investor’s favour.
Angel Investors Due Diligence
Due Diligence is the work done by an investor to understand the details of your company, and confirm it is a good investment. Due Diligence can be extremely detailed, going through every legal agreement your company has signed, or high level, only reviewing the shareholders agreement and pitch deck. Angel investor’s level of sophistication will result in a huge discrepancy between the levels of due diligence completed by investors. It is critical for founders to be ready for the due diligence that investors want to do, and a Data Room is a great way to prepare for that.
As we mentioned before, since Angels are individuals with different levels of private investment experience, one of the areas with the broadest spread is due diligence. Some angels will be comfortable with a pitch deck, articles of incorporation and subscription agreement, while others will want to review all available documentation in a data room.
A Data Room is a digital file location (think google drive or dropbox) where you have collected the documentation needed by investors to complete their due diligence. Data Rooms should not be given out immediately, and some companies use layers in their data room, it gives access to certain files immediately (pitch deck, projections), but with further information like employee agreements or client contracts kept behind a password wall. The more confidential details would be help for investors and only provided after an NDA has been signed.
It's important for founders to have data rooms and the information needed in them ready to go before speaking to investors, so that there is no loss in momentum when speaking to investors and moving your deal forward.
As companies grow and reach later stages, the amount of information expected to be in the data room will become immense. Series A and beyond data rooms should have extensive lists of legal documents, all agreements the company has signed, all customer orders and invoices, all previously signed investment term sheets, just to name a few.
Raising from Angel Investors via a Platform
Depending on the size of your round, and the number of angels you are looking to raise from, there are some potential benefits to be gained by using an investment platform (full disclosure, I am a co-founder and managing director of investment platform Equivesto).
Some of the more obvious benefits to using a platform are focused around the online aspect of the platform. It provides a digital online location to transact, digital document signing, moving the funds, and the ability to consolidate and simplify the investment process.
Beyond that, platforms can provide benefits relating to the due diligence and review process completed by the platform. Platforms in Canada that are operated by a licensed Exempt Market Dealer, are required to complete a full due diligence process called Know your Product on all companies before they can raise on the platform.
This detailed due diligence process creates a scenario where you as a company can provide all of the information to the platform for the due diligence that is needed, but the platform does not need to then provide that same information to all investors. Since the platform has completed the due diligence, it is them possible to keep the documents and materials private, and leverage the platform’s work to support investor due diligence without actually needing to provide all of the documents.
The platform also allows you to quickly disseminate the details of your raise in one location. Investors can visit the page to review your deck, additional materials, and complete the entire transaction process digitally, including signing investment documents and moving the funds. They can also easily share the information with other potential investors, and the digital page allows you to provide more detail than in a traditional pitch deck, including pitch/demo videos, and additional documents like projections and business plans.
TLDR: Raising from Angel Investors
Raising capital is like dating. You are looking for a partner to enter into a long term relationship with you, potentially even marriage. As a founder, you need to clearly understand the type of partner you are looking for, as well as be prepared to provide the things a partner will be seeking in you. Closing the investment and getting the money is like your wedding day, it is not an endpoint but hopefully is the start of a long and fruitful relationship.
Moving through the process with respect and self awareness is worthwhile and will make you happier in the end.
- Understand whether you fit as a startup
- Understand the stage of your business, and the types of investors who invest at that stage
- Research potential investors before you reach out to them
- Understand the differences between individual angels
- Understand How Angel groups work
- Understand Angel Investor Expectations
Knowing these basics will help ensure you are having the meetings with the right investors and are in the best possible place to provide a smooth investment experience for both you and them.