Angel investors offer a lifeline to small business owners. They invest their hard-earned cash in start-up businesses that can’t get funding elsewhere. In exchange, they often expect a share of that small business.
It’s a big risk! If angel investors get it right, the rewards can be amazing. But if they get it wrong, they risk losing their whole investment. It’s certainly not for the faint-hearted!
Here I take a look at the top three mistakes made by experienced angel investors. What have they learned from their errors?
1. Taking everything at face value
We’ve all seen Dragon’s Den. “I’m in – I’ll make you an offer!” the Dragons exclaim when they want to invest in a fledgling business.
But that’s only the beginning of the process. After the pitch comes the due diligence. That’s where the Dragons pour through the business’s financial information to find out if the pitch was accurate. What are the sales figures? What does the business owe? How much cash does it have? Are there any nasty surprises the angel investor should know about?
Chantelle Arneaud from Envestors (an investment platform connecting investors and entrepreneurs) warns that even that due diligence sometimes isn’t enough. Business owners can sometimes hide significant problems from an angel investor. She spoke to one angel investor who “recounts how a business failed to disclose that it owed a six-figure sum in VAT. This detail, when included, showed the business to be insolvent.” If the business goes bankrupt, the angel investor loses all their money.
To protect themselves, Chantelle advises that investors should “always work with organisations regulated by the Financial Conduct Authority (FCA). The FCA’s regulations are designed to protect the investor and require firms to ensure information is, ‘clear, fair and not misleading.’”
2. Not checking who owns the intellectual property
Intellectual property (IP) rights mean that the pitching business has exclusive rights to sell its product. Without IP rights, there’s a risk of copycat products being launched. Intellectual property can include inventions, literary and artistic works, designs and symbols, and names and images.
Angel investors don’t want to spend their time and money helping to build up a business only to have it copied by someone else.
But even if the business owner has the intellectual property rights for their product, angel investors still need to watch out. They should check that the business owns the intellectual property rather than the business owner themselves. That’s because the angel investor could be ripped off if the business fails. According to Chantelle Arneaud, there’s a risk “that if the business folds, the founder can walk away with the IP and set up an identical business in which you have no shares.”
3. Putting all of their eggs in one basket
Angel investors often prefer to invest in business sectors they know well. But that can come with its own problems. Anyone who only invested in restaurant businesses had a tough ride during the Covid crisis and subsequent lockdowns.
Chantelle advises that “to minimise risk, [angel investors should] build a diverse portfolio. Experienced angels know some investments will go bust, others will stagnate, and a few will skyrocket. Ensure you’ve got enough spread to balance the risk.”
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