Not all start-ups need external capital, but most do. And when they go for fund raising, the first stop often are angel investors. Angel investors are high networth individuals, who invest their personal capital in promising start-ups.
In the last few years, the number of individuals investing in start-ups have increased significantly. However, only a small percentage of start-ups are successful in raising funding from angels. A part of this can be attributed to the demand-supply mismatch. However, the success percentage can be considerably increased if entrepreneurs are aware about what the angel investors are looking for.
Sweet spots
Here are the sweet spots that angels are looking for while evaluating investments, based on data sourced from YNOS Venture Engine.
Firstly, let us look at the age of the start-up at the time of angel investment. More than 50 per cent of the angels invest when the age of the start-ups is between one to three years. There is also a reasonably fat tail. About 30 per cent of the investors also invest in start-ups less than a year old. At the other end of the spectrum, there are about 401 angels who have invested in start-ups that were more than 5 years old. Though angel investors invest across the age spectrum, the sweet spot is between one to three years.
Next, let us look at the founder composition. The founding team play an important role in the decision making of investors. The results show that the largest number of investors (close to 50 per cent) prefer the size of the founding team to be two. The interest to invest in single founder company is also reasonably high. About 40 per cent of the investors have invested in single founder companies.
However, the appetite dramatically drops when the size of the founding team increases to three or more. So the sweet spot is a two member founding team, followed by a single founder start-up.
Thirdly, the education and experience of the founders is another factor that investors closely analyse. More than the individual education and experience of the founders, the composite education and experience of the founding team is what the investors look at.
‘Educational score’
When the education and experience of the founders were converted to a quantitative score, it was found that the largest proportion of investors invested in those start-ups where the founders had a high education or experience score. When we move down the quartile, the proportion of investors gradually drop. The evidence clearly indicates that founders with strong education and experience attract a greater number of investors.
Finally, the size of funding round. Angels invest their personal capital and therefore cannot make large investments like that of venture funds. Since many angels would prefer to acquire meaningful stakes in the start-ups, their interest levels decline when the round size increases.
While the highest proportion of angel investors invest in funding rounds between ₹10-25 million, there is strong interest among the investors to invest in funding rounds up to ₹100 million. However, the proportion of investors significantly drops when the round size crosses ₹100 million.
Incorporating insights
Incorporating the insights from when, what, and how of angel investing can significantly improve funding success. In sum, the sweet spot for angel investors is a start-up between one to three years old, having two founders with high education and experience scores, and raising capital up to ₹100 million.
When the ball meets the bat in the sweet spot, the end result is a success. What holds for cricket, holds for angel investments as well.
(The writer is Professor, Centre for Research on Start-ups and Risk Financing, IIT Madras; Associate, Harvard Kennedy School, Harvard University)