When is a Startup Ready for Angel Funding?

Last week Forbes reporter Meghan Casserly began a three-part series examining the topic of angel investors. Her series is intended to help entrepreneurs better understand what is meant by the term angel investor and what types of investments they are looking for.

“An angel investor is a high net-worth individual who invests his/her own money in a startup in exchange for an ownership stake or equity in the company,” says Allison Finkelstein, senior director of funds management for TechColumbus, which manages Ohio TechAngels, the second largest active angel group in the country. For most startups, angel investors are a fundraising round that they seek out in what Finkelstein calls the “valley of death” —the point at which a company has run out of money from friends and family, but isn’t yet positioned to attract significant venture capital.

But how does an entrepreneur know when his/her company is ready for angel investors? “The first thing to point out is that most businesses are not appropriate for angel funding,” says Scott Shane, author of Fools’ Gold: The Truth Behind Angel Investing. In 2009, of the $17.6 billion dollars invested by angels, 19 percent went into software and 17 percent each was raised in healthcare services and industrial/energy-related startups, industries Shane refers to as expanding markets. Angel investors aren’t normally in the business of funding niche businesses. But if a startup is rooted in technology, the pastures are much greener for seeking out funding.

According to Shane, to be attractive to an angel, businesses should be part of an expanding market, able to show high return rates in a short period of time and there should be an exit strategy in place from the beginning.

For more, see Part 1 of Casserly’s report on Forbes.com and watch for Parts 2 & 3 in coming weeks.