post by:
Michael Goldstein
So you are looking to scale and grow your business and increase your cash flow? It’s time to understand Angel Investors – the good, the bad, and the ugly. Angel investors are not all bad. In fact, many small-to-large size businesses can benefit from the initial investment. Who couldn’t use an extra couple thousand dollars to get through the next hurdle? And someone wants to come along and just hand it over? Well, not exactly.
In the long run Angel Investors can be problematic and because you accepted the money, you are stuck in an agreement that no longer benefits you or your business. You are now responsible to someone else who has taken a stake in your company (equity share) instead of to your company itself. Let’s take a look at why angel investors may not be your best option.
What are Angel Investors?
Investments are an expenditure from which you expect to receive dividends because your investment is supposed to increase the value of that asset.
Basically, all of that fancy terminology means: you put in your own money in order to make money off of the business’s profits. Investments are usually referred to in terms of stocks or partial ownership.
Angel investors are wealthy individuals who lend you their money to increase your cash flow, improve inventory, or manage day-to-day finances. The angel investor is repaid with a percentage of equity in your business; meaning, they now own shares or equity in your company.
How Does Angel Investing Work?
You can find an angel investor through a host of websites of wealthy individuals looking to hand out their money in exchange for a cut of your profits. Almost like a crowdfunding page, you can outline how much money you need to raise, what you are going to use the money for, and what percentage of your revenue (revenue share) you will relinquish in exchange for the loan. Once you find one of these angels, you will engage in an agreement on what their share will look like. Typically you will be coughing up between 10-20% of your profits.
Pro tip: establish a clear end of agreement in the contract (we will talk more about this in the next section).
Once you establish the agreement, the angel investor will continue to draw their share until the agreement ends or they sell their ownership back to your or other investors when it becomes profitable.
Drawbacks of Angel Investors
Angel investors are not all bad. You get your lump sum up front to fund your business and you can potentially use that money in any way you want. The money’s use is established at the beginning of the agreement when the angel agrees to finance your endeavor. If the angel does not agree with how you plan to use the money, negotiations can be made and you can agree or decline the offer.
Once the agreement is in place, you are now responsible to your shareholder. When someone has equity in the company, their objective is to line their pockets. This can be beneficial because in order for the angel investor to make money, they need you to make money. Therefore, your investor may view this as a partnership. But all that means is that you are no longer in complete control of your business.
In the event that you are not increasing your sales and making higher profits, the investor’s 10-20% (or whatever your agreement states) is coming out of your bottom line. So eventually, you are not making money to put back into your business to become financially independent.
Alternatives to Angel Investors
Are you thinking angel investors are not the right fit for your business? That’s OK. Equity share is not the right option for everyone. This is why we have a few alternatives for your to consider: check out merchant cash advances (MCA), revenue shares, or business lines of credit.
1.Merchant Cash Advance (MCA)
The way MCAs work is that you receive the advance and repay based on a small percentage of your daily credit and debit card sales. You can receive a lump sum up front or receive a daily advance based on the previous day’s sales.
MCA interest is based on a factor rate of 1.1-1.9 times the lended amount. (If you borrow $10,000 and the factor rate is 1.5 your final total is $15,000). The factor rate ensures that you will not incur compounding interest for lengthy terms.
2. Revenue Share Agreements
Similar to merchant cash advances, revenue share agreements allow you to make small repayments without overloading your budget. With traditional term bank loans, you agree to pay a specified minimum payment every month. But what if you have a slow month and do not reach that minimum? Then you have a strain on your cash flow and risk paying even more in interest and penalty fees for being late.
Revenue share agreements are literally an agreement to share your revenue; essentially, you receive a lump sum loan from a financier and make repayments based on a percentage of your monthly revenue. Your payment is never more than what you make. In low performing months your payment is lower and high performing months means your payment is higher.
3. Business Line of Credit
A business line of credit is a great option to draw from an available cash flow as you need it, and leave it alone when you do not. Business lines of credit follow a similar format as traditional loans – you receive the money up front and make minimum monthly payments based on the amount you spend. Interest is applied on the principal balance and can be compounded if the balance is not paid in full within 30 days. You can pull the entire amount or draw smaller amounts in increments.
Business lines of credit function the same as a business credit card without a physical card to make purchases. You simply transfer the funds to your bank account and use the money as you see fit.