Keeping the Angels at Bay
Skip to content
Entrepreneurship Finance & Accounting May 9, 2016

Keeping the Angels at Bay

Startups should be wary of accepting too much money from angel investors.

An entrepreneur decides whether to pick an angel investor.

Michael Meier

Based on insights from

Scott R. Baker

For entrepreneurs who are eager to bring their new ideas to market, nothing gets the blood pumping like an early influx of cash. And with venture capital firms now waiting until later in a company’s development to invest large amounts—in part due to growing competition among early-stage funding sources—many startups rely on angel investors to get their business off the ground.

Add Insight
to your inbox.

In one sense, this new landscape is a blessing for startups: it has never been easier to reach a crowd of potential investors. But access to angels can also be a dangerous temptation.

“Angel investors are becoming a popular source of early-stage funding,” says Scott Baker, an assistant professor of finance at the Kellogg School. “That can be a positive thing, and for a lot of people, it’s hard to resist. But there are risks involved in accepting money from too many angels—it may not be to your long-term benefit.”

Baker sees three main reasons to be wary of accepting too much money from angels early on: it prevents a tangled investment structure that scares off venture capital; it helps entrepreneurs retain ownership of as much of the business as possible; and it keeps startups lean and disciplined.

“There are risks involved in accepting money from too many angels—it may not be to your long-term benefit.”

Set yourself up for eventual VC investment. “There’s a reason why most startups seek investment from venture-capital firms,” Baker says.

Though these firms may charge fees and expect to own a sizeable chunk of an entrepreneur’s business, they can also help accelerate a company’s growth. “They have expertise, they can connect you to a vast network, and they are willing to offer guidance. You want to be able to leverage that experience and those connections.”

With angel investors, the capital often comes with less support. Angels, after all, are typically investing much smaller amounts and may not be able to provide the same range of expertise or operational assistance that a larger VC can.

That loss of support is compounded for startups that rely too heavily on a large group of angel investors. That is because a complicated ownership structure is an unpredictable ownership structure.

“VCs don’t like to deal with too many prior investors,” Baker says. “It’s hard to go to a board meeting and discuss voting rights if there are 20–25 different investors, each with a small stake.”

Avoid giving up too much equity. Tempting as early investment may be, it is important for startups to take a disciplined approach to raising capital. More investors mean more obligations; the founders also surrender equity with each new ownership claim. “The farther back you can push fundraising, that’s going to be beneficial in terms of how much of the company you keep.”

Bootstrapping is one way to avoid giving up equity. For startups offering a physical product, launching a campaign on a crowdfunding platform allows the business to bankroll itself while demonstrating viability to more serious investors. The Oculus Rift, a virtual-reality headset, was first introduced through a Kickstarter campaign back in 2012; the company is now owned by Facebook, and its groundbreaking product hit the market in March, to great fanfare.

Joining an incubator is another option for growing a young business. Incubators offer office rentals to select tenants that are then able to take advantage of mentorship, networking, and resource sharing with companies at similar stages. Startups can take advantage of these opportunities without giving up equity. Some companies working in incubators may also be chosen for accelerator programs, which provide funding to help companies that are close to launch.

Incubators have two additional advantages as well. First, a well-known incubator can offer a kind of certification. “The good ones can give you a gold seal, which will draw more attention from V.C.s later on,” Baker says.

Second, incubators are a good place to gain expertise. An incubator provides its startups help with legal processes, HR details, or web design—allowing those companies to offload aspects of the business that are not part of its core competency. The Chicago-based incubator Insight Accelerator Labs, for example, helps startups that have developed new medical devices commercialize their innovations.

Don’t always take the maximum amount. In the highly competitive, highly uncertain world of startup fundraising, there is a tendency to seek out the maximum investment available. Some founders might look at the amounts other companies have raised and think: we should be raising that much, too.

Baker says founders should focus more on mapping out their own growth projection and communicating that projection to investors.

“You should be clear about why you need a certain investment,” Baker says, “and it has to be something specific: ‘We need to expand this manufacturing facility; we need to hire these six people.’ Investors will always want to see a well-reasoned pitch.”

Maxing out may also lead young companies to become overambitious, funding questionable initiatives without aiming at profitability., which launched in 2011 as a daily deal site selling contemporary home furnishings, squandered its early investment on an over-the-top marketing campaign—the company sent new members at least one email a day—and ultimately failed to attract new customers.

Of course, the strategy for seeking investment will depend on the type of company, which is why Baker cautions against taking a one-size-fits-all approach to fundraising.

“How you go about raising money depends on a number of factors,” he says, including the industry, type of company, and founder’s level of expertise. It’s important to know up front what kind of overall support you need.

Still, it is worth keeping in mind the downside of too much angel investment.

“You might be the kind of entrepreneur who only needs capital,” Baker says.“But capital is easier to find than expertise and the kind of support that pays off in the long run.”

About the Writer
Drew Calvert is a freelance writer based in Iowa City, Iowa.
Most Popular This Week
  1. How Much Do Boycotts Affect a Company’s Bottom Line?
    There’s often an opposing camp pushing for a “buycott” to support the company. New research shows which group has more sway.
    grocery store aisle where two groups of people protest. One group is boycotting, while the other is buycotting
  2. 5 Takeaways on the State of ESG Investing
    ESG investing is hot. But what does it actually deliver for society and for shareholders?
    watering can pouring over windmills
  3. Could Bringing Your "Whole Self" to Work Curb Unethical Behavior?
    Organizations would be wise to help employees avoid compartmentalizing their personal and professional identities.
    A star employee brings her whole self to work.
  4. When Do Open Borders Make Economic Sense?
    A new study provides a window into the logic behind various immigration policies.
    How immigration affects the economy depends on taxation and worker skills.
  5. Which Form of Government Is Best?
    Democracies may not outlast dictatorships, but they adapt better.
    Is democracy the best form of government?
  6. How Has Marketing Changed over the Past Half-Century?
    Phil Kotler’s groundbreaking textbook came out 55 years ago. Sixteen editions later, he and coauthor Alexander Chernev discuss how big data, social media, and purpose-driven branding are moving the field forward.
    people in 1967 and 2022 react to advertising
  7. What Happens to Worker Productivity after a Minimum Wage Increase?
    A pay raise boosts productivity for some—but the impact on the bottom line is more complicated.
    employees unload pallets from a truck using hand carts
  8. Why Do Some People Succeed after Failing, While Others Continue to Flounder?
    A new study dispels some of the mystery behind success after failure.
    Scientists build a staircase from paper
  9. What Went Wrong at AIG?
    Unpacking the insurance giant's collapse during the 2008 financial crisis.
    What went wrong during the AIG financial crisis?
  10. Why Well-Meaning NGOs Sometimes Do More Harm than Good
    Studies of aid groups in Ghana and Uganda show why it’s so important to coordinate with local governments and institutions.
    To succeed, foreign aid and health programs need buy-in and coordination with local partners.
  11. 3 Tips for Reinventing Your Career After a Layoff
    It’s crucial to reassess what you want to be doing instead of jumping at the first opportunity.
    woman standing confidently
  12. How Are Black–White Biracial People Perceived in Terms of Race?
    Understanding the answer—and why black and white Americans may percieve biracial people differently—is increasingly important in a multiracial society.
    How are biracial people perceived in terms of race
  13. Podcast: Does Your Life Reflect What You Value?
    On this episode of The Insightful Leader, a former CEO explains how to organize your life around what really matters—instead of trying to do it all.
  14. Immigrants to the U.S. Create More Jobs than They Take
    A new study finds that immigrants are far more likely to found companies—both large and small—than native-born Americans.
    Immigrant CEO welcomes new hires
  15. In a World of Widespread Video Sharing, What’s Real and What’s Not?
    A discussion with a video-authentication expert on what it takes to unearth “deepfakes.”
    A detective pulls back his computer screen to reveal code behind the video image.
  16. College Campuses Are Becoming More Diverse. But How Much Do Students from Different Backgrounds Actually Interact?
    Increasing diversity has been a key goal, “but far less attention is paid to what happens after we get people in the door.”
    College quad with students walking away from the center
More in Entrepreneurship