Is an angel investor a better option for startups than crowdfunding?

Startups today face a great number of challenges and, at the same time, lots of opportunities to succeed in today´s technology-driven ecosystem. The number of tools, apps, and technology-driven resources available in the marketplace has opened the doors to innovation.

When a group of entrepreneurs gets an idea for a business they must be reminded of the number of companies that failed. According to Quora, 92 percent of startups failed within the first three years. In addition, of those startups that did not make it, 74 percent ceased business operations due to premature scaling.

Startups will embark on a venture actively seeking affordable financing, and to grow over time into a profitable business. Funding a startup is paramount for it to survive. For our purposes, the next sections will discuss in detail angel investing and crowdfunding, which are ways to raise money for a startup.

The benefits and drawbacks of funding a startup through an angel investor

Startups at the beginning have limited resources, and a small budget to operate. In the case of angel investors, this investment group wants to assist startups and help them grow over time. Per Investopedia, an angel investor is a high-net-worth individual that wants to facilitate the growth of a company.

The first three years are crucial for a startup as 92 percent of them fail to survive beyond that point, according to Quora. (Source)

These investors provide seed money in exchange for an equity stake in the startup or business. Once the company generates profits the angel investor can sell their shares for a profit. Let’s remember the probability of a startup failing is high, so having someone in the initial stages changes the likelihood of going bankrupt.

It is perfectly normal for an angel investor to invest somewhere between $25,000 and $100,000. This is just a ballpark figure. It could be a larger investment depending on the industry and size of the company.

On the contrary, since you have a partnership with a business professional, you have responsibilities and obligations. It is not necessarily a binding contract, but the pressure will exist since they expect revenues to be generated. They will be actively present in the decision-making process, so having some pre-existing agreements written down will reduce conflicts about how to proceed with the product or service you offer.

The pros and cons of utilizing crowdfunding

Since the internet came around, crowdfunding has become a financing force for startups. This practice essentially uses funds collected to finance a project or a venture that comes from a large group of investors. It is a form of crowdsourcing and of alternative financing that went from raising millions to now billions of dollars a year.

Websites like Indiegogo (pictured) help startups acquire more funding from a huge number of investors. (Photo by Sebastiaan ter Burg via Flickr. CC BY 2.0)

In 2014, $16 billion was crowdfunded, and in 2015, the estimates were $34 billion. It is anticipated the figure will be again higher than previous years. What has accelerated the growth of this process of gathering capital is the passage of the 2012 Jumpstart Our Business Startups Act. Young businesses can raise up to $1 million per year and do not have to register with the Securities and Exchange Commission (SEC).

One of the attractive aspects of crowdfunding is they do not have to give up ownership or control when raising capital. To kind of get away with this scheme is to use a rewards-based approach. Then again, one of the perks of this type of funding is you increase visibility. One of the hurdles for startups is spending their limited capital on marketing their products or services. With this service, you can attract potential investors that much easier.

Be as it may, this funding is revolutionary but has conditions. It is not a no-strings-attached investment fund. Be mindful that the cap is set at $1 million, and this may not be enough for companies to expand fast enough. The other downside to this is it comes with expensive fees. Businesses using this platform can expect to pay somewhere between five to 10 percent in fees alone.

Takeaways and conclusions

Crowdfunding and angel investors are investment groups that can open many doors for startups, and can help expand the business. Opening your own company carry with it plenty of risks, and potential investors are very much aware of this reality. It all comes down to how your service or product performs.

It seems the tech industry startups naturally gravitates to crowdfunding because many companies before them found success using this system. But not all potential tech businesses are created equal. The idea must be well-thought of and entrepreneurs will face lots of rejections when they pitch their company´s services. For those who do succeed they understand that giving up is not an option.

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DISCLAIMER: This article expresses my own ideas and opinions. Any information I have shared are from sources that I believe to be reliable and accurate. I did not receive any financial compensation in writing this post, nor do I own any shares in any company I’ve mentioned. I encourage any reader to do their own diligent research first before making any investment decisions.