How Do Business Angels Make Money?

As an entrepreneur, you may have heard of business angels as a source of funding for your business.

But how do business angels make money?

In this blog post, we’ll explore the various ways that business angels generate returns on their investments and the factors that influence their decision-making process.

By understanding how business angels make money, you’ll be better equipped to approach and negotiate with potential investors.

Equity investment in exchange for an ownership stake

One way how business angels make money is through equity investment, where the business angel provides capital in exchange for an ownership stake in the company. This means that the business angel becomes a shareholder in the company and is entitled to a portion of the profits and any potential increase in the value of the company.

The size of the ownership stake will depend on the amount of capital the business angel is willing to invest and the valuation of the company at the time of the investment.

Business angels often take an active role in the companies they invest in, providing mentorship, guidance, and access to their network of contacts to help the company grow and succeed.

In return, they hope to receive a financial return on their investment through the company’s future success.

Exiting the investment through a sale or IPO

Another way how business angels make money is by exiting the investment, which typically involves either a sale of the company or an initial public offering (IPO).

If the business angel decides to sell the company, they may do so to another company or individual, or through a process called a “secondary sale,” where the business angel sells their ownership stake to another investor. The amount of money the business angel receives in return will depend on the value of the company at the time of the sale and the size of their ownership stake.

Alternatively, the business angel may choose to exit their investment through an IPO, which involves selling shares of the company to the public on a stock exchange. In this case, the business angel will receive money for the shares they sell, and they may also continue to hold on to a portion of their ownership stake in the company.

In both cases, the goal of the business angel is to receive a financial return on their investment through the sale or IPO of the company.

Factors that influence a business angel’s decision-making process

You may be wondering what factors influence a business angel’s decision to invest in your company. There are several key considerations that business angels take into account when evaluating potential investments.

First, business angels typically look for companies that have a solid business model and strong growth potential. This means that the company should have a clear plan for generating revenue and should be able to demonstrate that it has the potential to scale and become a successful business.

Second, business angels often prioritize companies that have a competitive advantage in their industry. This could be a unique product or service, a patent or intellectual property, or a strong team with a track record of success.

Third, business angels may consider the stage of the company when deciding whether to invest. Early-stage startups often carry more risk, but they also have the potential for higher returns if they are successful. Later-stage companies may be more established and have a proven track record, but they may also have less room for growth.

Finally, business angels may consider the personal fit between themselves and the entrepreneur. They may be more likely to invest in companies led by entrepreneurs they believe they can work well with and who share their values and vision.

Dilution of ownership stake and managing expectations

It’s important to understand that taking on external investment often involves dilution of your ownership stake in the company. This means that as the company raises capital, the percentage of ownership held by the founders and existing shareholders may decrease.

It’s also important to manage your expectations when it comes to the potential return on investment for business angels.

While it’s natural to hope for a high return, it’s important to remember that many startups fail and it can take years for a company to become profitable. Business angels are typically aware of this risk and may be willing to wait for a longer time to see a return on their investment.

The role of due diligence in the investment process

If you’re seeking investment from business angels, you can expect them to conduct due diligence on your company before committing to an investment. Due diligence is the process of thoroughly evaluating a potential investment to understand its risks and rewards.

Business angels will typically review a variety of information about your company, including financial statements, market research, and business plans. They may also conduct interviews with your team and other stakeholders to get a better understanding of the company’s operations, culture, and growth potential.

The due diligence process can be time-consuming, but it’s an important step for both you and the business angel. It helps the business angel make an informed decision about the investment and helps you understand their expectations and any potential areas of concern.

By being transparent and proactive during the due diligence process, you can build trust and strengthen your relationship with potential business angel investors.

Alternatives to equity investment

You may be open to exploring alternative financing options beyond equity investment from business angels. Here are some options:

Debt financing

This involves borrowing money from a lender, such as a bank or credit union, and agreeing to pay it back with interest. Debt financing may be a good option for companies that need a smaller amount of capital and can demonstrate the ability to make regular payments.

Crowdfunding

This involves raising small amounts of money from a large number of people, typically through an online platform. Crowdfunding can be a great way to test market demand for your product or service and build a community of supporters.

Grants

This involves receiving funding from a government agency, foundation, or other organization for a specific purpose, such as research and development or expansion into a new market. Grants may be competitive and may require a detailed application process.

Revenue-based financing

This involves receiving funding in exchange for a percentage of future revenue. The lender is paid back through a percentage of the company’s sales over time, rather than through equity ownership.

By exploring a variety of financing options, you can find the best fit for your company’s needs and goals.

Final thoughts

You should now have a better understanding of how business angels make money through their investments.

By providing capital in exchange for an ownership stake in the company, exiting the investment through a sale or IPO, and considering factors such as the company’s growth potential, competitive advantage, and personal fit with the entrepreneur, business angels hope to receive a financial return on their investment.

It’s also important to understand the potential dilution of ownership and the role of due diligence in the investment process.

In addition to equity investment from business angels, there are also other financing options to consider, such as debt financing, crowdfunding, grants, and revenue-based financing.

By weighing the pros and cons of each option, you can find the best fit for your company’s needs and goals.

What’s your entrepreneurial potential? Find out with our self-assessment!