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How do business angels see success when they invest in businesses?
Angel investors have the power to turn startups into global successes.
Their capital, plus knowledge and support, is often pivotal in realising entrepreneurial ambitions.
But, for these high net worth individuals, assessing the many opportunities available to them and picking a business to back can be daunting. Choose wisely and strong returns and the fulfilment of supporting an exciting, innovative enterprise may follow. Conversely, an ill-judged choice may dent their much-needed willingness to support new and growing business, as well as their portfolio value.
Gauging the success of startups is particularly challenging in the absence of any real commercial data. Many other factors besides sales will come into play. Every investor is different and each will have their own motives for investing in businesses. There are, however, several factors commonly considered to indicate imminent success amongst angel investors.
When the early signs are good
For startup businesses without a trading history, the results of early trials are often used as a signpost to impending success.
Beta-testing, a concept usually employed in the tech sector, measures whether the product meets the demands of target customers. Business angels can draw various conclusions from the results of pre-launch trials of products and services.
For example, is the solution user-friendly and delivering what it is supposed to? Is the management team able to iron out any flaws or improve its offering where required? Does the sign-up rate for the tests suggest there is enough demand for the startup’s idea?
Many beta-tests today have an underlying marketing motive. Generating users online to take part in tests is an excuse to spread the word about the business.
Angel investors will be keen to see signs of traction - perhaps through web traffic and social media noise - among customers.
A compelling, disruptive market proposition
Most savvy investors with business successes behind them know a good opportunity when they see one. Among the most exciting startups and SMEs to invest in are those that have exclusively discovered a way to disrupt a ripe and lucrative market in such a way that the proposition to customers is almost a no brainer.
Crucially, this disruptive opportunity should not have been identified by any other party. When the low-cost telecoms service Skype emerged in 2003, for example, suddenly consumers could make international calls for a fraction of their usual cost, transforming what people were willing to pay for telecoms services. Such opportunities are rare but extremely enticing for investors. Other compelling scenarios for business angels include disruptive solutions in markets where the infrastructure or ecosystem already exists to scale up quickly. Uber harnessing existing GPS technology to roll out its services globally is a prime example.
Investable products must have a clear competitive advantage. This could stem from various sources such as a patented piece of innovation or a new price point made possible by a disruptive approach to the supply chain - and importantly, business angels should carefully assess the size company’s market opportunity.
An all-star team
The old cliché that investors back people not businesses is so engrained in enterprise rhetoric because it is largely true.
The founders behind the startup are a good indicator of its potential for success. Investors aren’t looking for every seat around the boardroom to be filled from the beginning. A typical tech start-up, for example, may only have a technical/product lead and a customer-facing managing director.
Angels want to see a number of traits including passion, determination, integrity, relevant experience, market knowledge and a willingness to learn and take advice on board. A startup with a successful future will also have plans in place to fill key management roles as the business scales up.
Clear priorities between essential and nice-to-have additions to the team should be set out, whilst good talent retention can also be a major highlight for investors.
The business model guides the way to startup success. When presented to investors, it should not be so simplistic that it skates over important considerations. At the same time, it shouldn’t be so complex as to confuse even the most strategic business minds.
The foremost question the angel is looking to answer is ‘will the model actually work?’. If all evidence points to an emphatic ‘yes’, the angel’s investment moves a step closer. Revenue streams, cost components and investment needs should all be carefully considered.
In a 2017 study by the University of Glasgow’s Adam Smith Business School, 87% of angel investors cited a company’s cash flow as a key factor in their investment decision. It also highlighted a preference for entrepreneurs financially tied into their business. The report found that almost nine in 10 business angels would find it too risky to back an entrepreneur that had not put significant investment into their own startup.
Successful businesses must be able to demonstrate that they can continue operating on a day-to-day basis while also stretching ahead with growth plans. The company valuation should also be justifiable.
Meanwhile, how stable is the cash flow situation? If not yet trading, how long will the business take to become cash flow positive? An accurate calculation of the costs required to become established in the chosen market is needed.
Success to some sophisticated investors means much more than monetary gains. They may also consider the company’s positive impact, socially or environmentally, as a signpost of success. This type of angel, known as an impact investor, will be keen to know what difference the company will make to the world once successful.
Positive impact doesn’t necessarily mean solving some grand global challenge. An angel might see a company’s intentions to bring jobs, investment or housing to a local community as impactful and therefore worthy of support.
Making an investment into a startup
Investing into startups isn't something that's restricted to business angels. Particularly in more recent times most people have the ability to invest into startups due to the prolific growth of online platforms.
But regardless of whether you're investing as an experienced business angel or it's your first foray into startup investing, it's important you take the time to truly determine whether the opportunity is right for you as an investor.