Study notes

Sources of Finance: Business Angels

  • Levels: AS, A Level
  • Exam boards: AQA, Edexcel, OCR, IB, Other, Pre-U

Business owners often report that company finance of £10,000 to £250,000 can be very difficult to obtain - even from traditional sources such as banks and venture capitalists. Banks generally require security and most venture capital firms are not interested in financing such small amounts. In these circumstances, companies often have to turn to "Business Angels".

Business angels are wealthy, entrepreneurial individuals who provide capital in return for a proportion of the company equity. They take a high personal risk in the expectation of owning part of a growing and successful business.

Businesses Suitable for Angel Investment

Businesses are unlikely to be suitable for investment by a business angel unless certain conditions are fulfilled.

(1) The business needs to raise a reasonably modest amount (typically between £10,000 to £250,000,and is willing to sell a shareholding in return for financing. Equity finance of over £250,000 is usually provided by venture capital firms rather than business angels. The exceptions are when several business angels invest together in a syndicate or when business angels co-invest alongside venture capital funds. The sums raised can easily exceed £250,000. Raising finance in the form of equity (shares) strengthens the business' balance sheet. Banks (or other lenders) may then be willing to provide additional debt finance.

(2) The owners and managers of the business are willing to develop a personal relationship with a business angel. This is important. Typically, business angels want hands-on involvement in the management of their investment, without necessarily exercising day-to-day control. This relationship can be a positive one for the business. A business angel with the right skills can strengthen a business by, for example, offering marketing and sales experience.

(3) The business can, and is prepared to offer the business angel the possibility of a high return (usually an expected average annual return of at least 20%–30% per annum). Most of this return will be realised in the form of capital gains over a period of several years.

(4) The business can demonstrate a strong understanding of its products and markets. Some business angels specialise by providing "expansion finance" for businesses with a proven track record, or in particular sectors. This enables an already successful business to grow faster. Business angels are also a significant source of start-up and early-stage capital for companies without a track record. A business plan based on convincing market research is essential.

(5) The business has an experienced and professional management team - as a minimum with strong product and sales skills. If there are weaknesses in the existing management team, a business angel can often provide the missing skills or introduce the business to new management.

(6) The business can offer the business angel the possibility of an 'exit'. Even if the business angel has no plans to realise the investment by any particular date, the angel will want the option to be available. The most common exits are:

- A trade sale of the business to another company. - Repurchase of the business angel's shares by the company. - Purchase of the business angel's shares by the company's directors or another investor.

Finding an angel

Many contacts are made informally.For example: personal friends and family; wealthy business contacts;major suppliers and clients of the business. Investors can also be found by approaching formal angel networking organisations. Many of the most active business angels use these networks to find out about interesting investment opportunities.

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