What Do Angel Investors Look For In A Startup Investment? (2024)

No two angel investors share the same goals. While one breed of investor may rely on professional expertise and choose a handful of companies to invest in, another species may cast a wider net into uncertain waters. Some angels may be in it for the IRR, some for the innovation, while few may have even moved beyond the pale to care not just about numbers but also about meaningful contributions to the environment and society.

This guide will eschew these subtleties to walk you through thebroad factors angel investors look forwhen considering funding startups. We'll look at elements like the team, product, financials, deal terms, and more. And sincereturnsmatter so much to investors, we'll take a deeper dive into what angels get in return for their backing. All right then. Let's get cracking on what angel investors like to see before signing the check!

Part One: Team, Product, Customer and Market

The quality of the founding team tops many growth-stage angel investors' checklists. At this stage, the startup's idea is still largely unproven. Thus, angels need to trust the capabilities of the founders and their likelihood of executing their ideas.

The ideal founding team may have a track record of scaling companies, deep industry expertise, and networks to leverage. Serial entrepreneurs who have started multiple businesses may be attractive.

Beyond direct startup experience, angels also look for founders with general management skills — like marketing, finance, operations, and technology. If the founders are lacking in certain areas, angels evaluate whether they've pulled together advisors and mentors to fill gaps. Recruiting high-quality support in areas like legal, accounting, marketing, engineering, and design demonstrates strategic thinking.

After the 'Team' box is ticked, we move on to another crucial area...

The Product and Traction

Angels know it takes time and money to turn an idea into an actual product. They love to see startups that have made initial progress developing and validating their offering. A minimum viable product (MVP) or prototype shows that the concept is viable beyond a hypothetical business plan. Traction with pilot customers takes product development a step further.

If the startup has users to test the product and provide feedback, that's a signal the offering satisfies a market need. Ultimately angels want to see that the product has a clear purpose, solves a painful problem, and taps into a sizable market opportunity. Fundamentally, they invest in products poised to delight customers.

Customers: Finding the Ideal Buyer

Speaking of customers, nothing convinces investors like actual user demand. Angels may be impressed when startups make those critical first sales or land marquee pilot customers for early product testing. Even small customer wins demonstrate real-world product/market fit and the sales process. They show that the startup can find and attract users amidst competition.

Landing key distribution partners helps startups expand their reach and build credibility. Customer traction removes much of the risk and uncertainty for angels. With little data to analyze, user adoption provides tangible evidence that the product delivers value.

Next up, we have the...

The Market Opportunity

Angels don't just evaluate startups in isolation — they look at the market potential. They want to understand the startup's opportunity within the competitive landscape. They may want to know if there is enough room for major growth and if the startup has defensible competitive advantages The market also impacts potential exits. Angels may target high-growth markets where large acquirers could locate the startup's technology, customers, or talent. Those represent ideal exit pathways (more on them later)

With the Team, Product, Customer, and Market out of the way, let's come to part two of the blog: a major crux of what angels investigate before investing...

Part Two: Financials, Deal Terms, and Exit Potential

Let's get into the numbers a little, shall we? Angels may also choose to carefully analyze a startup's financials like the income statement, balance sheet, cash flows, and projections. Angels want to understand capital efficiency. How long will their investment and other cash last? When will the startup need to raise again?

Efficient growth is key. Nathan McDonald , Chairman of Keiretsu Forum Northwest adds more context:

Angels want contractual protections so their stake isn't excessively diluted by future fundraising. Common provisions include pro-rata rights and rights of first refusal.Pro rata rightslet angels invest proportionally in future rounds to maintain ownership percentage.Rights of first refusalgive angels the option to purchase newly issued shares before others can.

These provisions are typically part of an investment agreement or shareholders' pact. They give angels a level of control over maintaining their stake instead of being crammed down by future investors. Angels expect hockey stick growth projections to show a massive scale. Those forecasts are taken with a grain of salt. But paired with capital efficiency, they demonstrate potential.

Next up...

Deal Terms

Deal terms are the fine print that aligns incentives between founders and investors.The right deal, neither too hot nor cold, may lead an angel investor to consider funding. While the proposition is risky, angel investing makes the most sense when interests are aligned for the long haul. Deal terms help keep things balanced between both sides. Angels want provisions that protect their investment, prevent extremes, and ensure proper governance.

Typical terms angels scrutinize include:

• Liquidation preferencesdictating who gets paid first if the company is sold or shuttered
• Voting rightsdetermining control between founders and investors

With terms done, we now come to what it all comes down to at the end of the day –

The Exit Potential

Exits may be the golden key to successful angel investment. It’s where the reward meets the road. When reviewing a potential investment, angels may ask several questions about how the founders envision one. Seeing a viable path to liquidity is crucial. Whether it is an acquisition or IPO. Otherwise, angels are stuck holding an illiquid private investment indefinitely.

Angel Investor Hall T. Martin says, “More often in the angel investing world, deals that are meant to be a rocket to the moon, go sideways and it turns out to be a nice lifestyle business for the company, but there's no exit for the investor.”

Essentially, angels want to see a believable pathway to selling the company at a high multiple on their invested capital within a 5-7-year timeframe. Those exits make the risk worth it.

Great. Our foundation on what angels look for while evaluating a pitch and financials is set. Let’s crown the three-part structure with something that makes all the difference in the end: returns.

Part Three: What do Angel Investors Get in Return? Guide to IRR and ROI

We're shifting gears and finally talking about returns — how angels make money on investments. An angel may allocate significant personal capital in hopes of an upside of magnitude. That’s the whole point of going beyond stocks, bonds, and other safer assets. But to set realistic return expectations, we need to dig into the data on angel investing returns.

Hall Martinspoke to us about returns, remarking:

In other words,ROI(return on investment)doesn't account for the time your money is locked up.IRR (internal rate of return)is a little more complex and factors in time by showing your annualized return.

For example, a 3x return over 3 years is a 44% IRR. But a 3x return over 5 years is only a 25% IRR. The slower exit results in a much lower annualized return, even though the multiple is the same. ROI is your total return or net profit regardless of time.

Now, what returns do angels typically achieve?

• An oft-cited2007 study by Robert Wiltbank and Warren Boekeranalyzed returns data from 539 angels and over 1,100 exits. It found the average return was 2.6x the capital invested over 3.5 years. That equates to a27% IRR.
• Another study by the Angel Resource Institute  reviewed 245 exits across 20 angel funds. The average return multiple was 2.5x over 4.5 years, or a22% IRR.

However, data can only hint at the variations that come to pass in each angel portfolio. Returns will vary widely by individual investment. According to Hall Martin, it's fair to expect 1 in 10 investments to be a home-run investment. The outsized winner compensates for the duds.

But hang on, even though the team, the product, the market, the risks, the financials, the exit, the IRRs, and the ROIs matter, it's not all about the money...

The Ideals Angels Seek

Throughout this guide, we've focused on what angels look for. But it's important to remember many angels invest not just for financial returns but also for the experience. They enjoy giving back to their community, mentoring founders, networking with peers, learning about new technology, and simply being involved in startups again. Angels get adrenaline, an intellectual challenge, and even fun out of investing. These invaluable motivations are a big part of the angel experience.

In summary, what do angel investors look for? Here are the key takeaways:

• Angels emphasize founding team, traction, market opportunity
• A fair returns benchmark could be 10x ROI or 20%-30% IRR.
• Dilution protections are a big yes and help angels maximize returns
• Exits are crucial - angels want viable paths to liquidity
• Deal terms keep incentives aligned between founders and investors
• There are plenty of non-tangible benefits too!

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