An Angel or Seed Investor is an individual who provides capital for a Startup instead of ownership equity. Some Angel investors work as groups providing a crowd funding, but there are many isolated individual angel investors.
They typically invest their funds and not a manged pool of funds the way venture capitalists do the same. The funding is taken at a stage of initial stage of a Startup and is more for survival rather than going in for commercial production of an innovative product.
Failure of a Startup
For funded Startups, there is a lot depends on the terms you agreed while taking the investment. If the Angel investor is a major shareholder in your company, he/she has an equal stake in the success/failure of the company. Some professional investors will evaluate the situation carefully and will value the integrity and openness. They will try to help you out of the current situation and will also provide you backing in difficult times or worst case, a complete failure, and closure of the Startup. You may hire freelancers instead of employees at the initial stage to reduce the risk.
The Angel Investors invest in a Startup, and everything goes well for the initial stage. The major stake is with founders (which will be the situation in 90% of the Startups). Something goes wrong with a change in market situation/cash flow of the company. The company starts going down on cash flow and can’t recover after genuine efforts. The investors get mad at the founders, and founders get frustrated. There are allegations and either the founders take major losses, or the worst thing is there can be a law suit. Everyone exits and the Startup gets closed with a bad feeling and broken relationships. For founders, it is a major set-back, and they have to start all over again and may be with a new idea next time.
In any business, traction is important, and without traction, the business can’t exist. If the team is not formed quickly and is not productive, the plans only remain on paper, and nothing concrete happens. The business may start with great planning and Angel investment but if the business is not progressing as planned, the investors won’t be interested in any further investment and will only look for the first possible exit.
No trust between the founders or business partners is another big issue with Startup firms. You may see two/three co-founders at the start of the business, but eventually, if someone from the co-founders leaves the business, it is an alarming situation with investors, and unless there is an equally strong substitute, the Startup may start seeing the immediate effect of the exit of a co-founder. In this situation also, the investors may start the exit process.
The founders start on a good note and raise funds from Angel investors for the initial survival phase. If the market response is negative or neutral for first product release and people are not interested in the product, there is a big gap between the assumption and reality. The market may not be ready or interested in your product, and the traction will be very low. With this situation, the investors may give you some time to re-design the product or add more features, but may not invest more.
Another situation is about a faulty/buggy product. If the product release creates a negative feedback (for example all negative reviews on your new Mobile App), the name and product may need to be pulled out of the market to avoid further damage. The Angel investors will be very cautious even if the product starts seeing a traction at the second attempt. You may get very less funding or no funding for the second round.
The Angel investors and founders agree to engage in a relationship with the profit/loss share as per their stake in the company. The risk is high for both parties, and they accept the same while signing the MOU.
If the Startup fails and both parties agree that they have to wind up the business and avoid any further losses. It could be a very professional, thoughtful decision and without getting into legal options. If both parties can take up the loss, agree to pay to the vendors and employees and wind up this business that is the best situation which can happen to a Startup. It may result in a lot of personal liability (for a proprietary firm) but can avoid any legal suits.
What do Experts say?
You will hear some experts clearly mentioning that the founders don’t repay investors if a Startup fails. They say that the investors are taking a calculated risk and own a share of the company. If the Startup is successful, they get the benefits, if the Startup fails, they share the losses. Everyone takes the profit/loss as per their share value as the share loses its value when the Startup fails. The Startup is an entity, and it is not same as founders. The liability of founders is extremely important, and that is why the Startups register themselves as a Company and don’t run it for a long time as their sole/ownership business.
If the founders owe the refund of money, that is a debt (a bank loan) and not an investment. It is a key difference between investment and a bank loan. The bank has no stake in your business, and even if you fail, the back still expects you to repay the loan.
Keep reading more information on freelance websites and make sure you understand the Startup financing. Take proper care while registering your Startup as a company and getting into an MOU/contract with investors. When the investors invest funds accepting all risks, they are ready to share the loss also. The share value is the key to investment and offer the shares with proper advice and get into a legal contract in a way to protect your personal assets. With proper care, the founders will not be liable to pay to the investors in case of failure of a Startup.