How Do Angel Investors Fund StartupsMarch 10, 2020
From initial pitch to funds in the bank: your essential guide to startup deal flow
If you’re an entrepreneur looking for angel investments to fund your startup, it’s essential to understand the process from start to finish. Doing so will give you a realistic picture of what to expect as you move from pitching your idea to building a term sheet, securing that first round of funding, and beyond.
Step 1: Pitching
Let’s start with the pitch, which is usually the first filter used by angel investors in their search for diamonds in the rough. Note that a pitch could be an informal conversation over coffee, a formal one-on-one meeting in an office, or part of a “group pitch” where multiple entrepreneurs present their ideas in succession to multiple angel investors as part of a regular forum.
After hearing your pitch, how do angel investors decide if your startup warrants further examination?
Every angel investor will have a somewhat different screening or “scouting” process, but here are the most common questions asked by angel investors:
- Does this investment fit the angel’s focus and philosophy ?
- What is the upside potential?
- Are there any serious red flags that would instantly cross this investment off the list?
- How does this opportunity compare to other opportunities currently in the angel’s pipeline?
From an entrepreneur’s perspective, the important thing to note here is that being rejected by an angel doesn’t mean your idea is worthless. It’s entirely possible that your idea just doesn’t fit with that particular angel’s philosophy or focus – so don’t get discouraged.
Step 2: Building consensus
If you’ve piqued the attention of a solid angel investor: great! Your startup clearly has some merit. However, if you’re planning on raising serious money, you’ll need to get more than one angel investor on board. Unlike with VC funded startups, where a large pool of money can be allocated to a startup with relative ease, individual angel investors bring relatively small sums to the table. In the process of building consensus amongst a group of angel investors, you may end up having to deliver your pitch again, in addition to answering more detailed questions.
Step 3: Due diligence and ballpark valuations
Angel investors, like all good investors, will conduct due diligence on your team and the projections you’ve made in your pitches. The level of due diligence conducted by angel investors varies widely, but you can be sure that there will be more scrutiny as you get closer to a final deal. At this still relatively early stage, you can expect to begin preliminary talks about the prospective deal terms. Before more time and effort is spent on due diligence, this is a good opportunity for both sides to see if they are in the same ballpark. If they are, the next step is:
- A dive into how angel investors perform due diligence on their potential investments
- How does an early stage investor value a startup?
Step 4: Drafting the termsheet and deal syndication
As you move towards clearer terms for your potential deal with your lead angel investor, you’ll also need to navigate the tricky process known as deal syndication. The entrepreneur and the lead angel investor will have to work together at this stage to onboard the right investors at the right level of equity and within a reasonable amount of time. The factors to consider here are:
- alignment between investors and the startup’s vision.
- expertise and connections brought by each additional investor.
- whether additional investors agree to the broad terms of the deal (if the deal has to be renegotiated for each additional investor, the process will drag on for months).
Step 5: Getting the lawyers involved
Before any deal can be formalized, the broad termsheet needs to be translated into legalize. While a termsheet is typically just 3-5 pages in length, the legal documents required to guarantee the equity taken by investors and other terms of the deal can run into the hundreds of pages. These documents are drafted by one side before being reviewed carefully by the other side’s legal team. This is a process that generally takes between a week and month.
Step 6: Signing the deal
Once the legal documents have been agreed upon, they are sent out to all stakeholders for signing. This, at long last, is the stage where cheques are written and funds are transferred. Congratulations! You’ve just completed your first funding round.
Read more: Startup Funding Rounds Explained - From pre-seed to Series C, your essential guide to funding rounds for startups