New business owners and entrepreneurs may have doubts about their credit when taking risks with a startup. Yet angel investors are nearby to build confidence, relying on entrepreneurial instincts. Turning to angel investors is not about borrowing money on credit. When working with angel investors, the owners give up a portion of their share and do not borrow money in a way that is linked to credit scores.
Angel investors rarely check credit and generally do not care about scores. This is because the credit scores assess loan risk and not the risk of losing money on investments. Angels are prepared to invest their own money to provide guidance and mentoring to new business owners and entrepreneurs. Some angel investors will check credit scores after a favorable decision has already been made, as part of a background check.
Once you recognize the nature of angel investing, it helps to understand the traits the investors are looking for beyond credit scores. For example, the benefactor can ask specific questions and perform other types of background checks. Low credit scores may indicate past failure, but there are proper steps you can take that will help keep the new enterprise pointed towards a promising future, even to angel investors.
Do Credit Scores Matter to Angel Investors?
Angel investors don’t necessarily need to look at your credit score (regardless if it’s low), because although a newer enterprise may be considered high-risk, it can have high-income potential, and that’s what they’re more interested in.
To that end, investors would rather look at your credit history, as this can tell them where your business currently stands: for example, a newer business is often too young to have a long history and access to multiple lines of credit. If most of your income is being used to pay back debts, then this could be seen as a red flag to investors, as there is a chance they won’t be seeing a good return on investment.
In other words, investors may evaluate the startup owner’s credit history just to confirm that they will offer their money to someone who can manage their own financial obligations. They want to see that you are not a credit defaulter even if you don’t have a good credit score.
What Should I Focus on Besides Credit?
Because angel investors are not concerned with credit scores, rather than put all your energy into improving your scores for them, you should prepare answers to these vital questions commonly asked by angel investors:
- Have you acquired any customers?
- What is your strategy for marketing?
- What will stop major companies in your arena from copying you?
- Is the company already serving the largest client in the business?
- Does an industry titan back them?
- Did the founders sell a startup or build something huge in the past that failed?
- How far will the funds get you?
What is Most Important to Angel Investors?
Many factors are more important determinants than credit scores to angel investors, such as:
- Vision Statement
- Return on Investment
- Exit Strategy
- Business Plans
- Equity Ownership
Investors want to see a developed vision statement. Your “why” or reason to succeed is what keeps everyone’s motivation strong when the going gets tough. Every startup can reach a moment when they need to change the model to solve a new problem. Success comes when the partners are more tuned to the “why,” and remain flexible with the “how” components.
Return on Investment
The investor usually expects a higher rate of return than traditional investments. In fact, according to The Balance, “an angel investor typically looks for a return of 25 percent or more.” This contributes to why they often prefer to look at a business’s income potential instead of credit scores.
“A startup’s valuation should be in line with similar companies in the same industry, city, or region.” (Source: Crunchbase) Valuation is essentially the “value” of your business. What is your capitalization table? What’s your experience in this industry? What can you offer that provides additional value to your product and service offerings?
Business plans are important to any new business, and it’s important to investors, too. Your model should include details of how you plant to market and grow the business, even though the business may be seeking investment in a pre-revenue stage. This is your opportunity to demonstrate the capacity to dominate a specific market.
Angel investors look for an exit strategy in two to four years to withdraw their money. This is because they foresee viable alternatives to ensure a return of their invested capital before business relationships start.
Investors or the professional management team choosing the investments want assurances that the business proposal is sound, so they will likely want a formal shareholder agreement. This funding relationship can work when the owner does not have sufficient cash flow or collateral for a loan, because owner offers equity ownership and a share in the profits, instead. Angel investors are ready to invest typically up to $500,000 in return for equity.
Background Checks are Part of the Mix
Besides the above elements, angel investors may also consider running a background check on you and your business. What they discover in the report may impact their decision to finance your endeavor.
A background report uncovers the following:
- Any legal issues: You have been sued or you sued others
- All loans: Issues with regular late payments or defaults
- Article search: Unusual circumstances where you are mentioned
- Employment verification: Validation of your prior employers
- Education verification: The degrees you have received
- Criminal record: Any charges and convictions
Other components will include details on the owner’s past, including former business history.
If bumps show up and the investors are informed about these instances beforehand, then there is less chance their imagination will jump to negative conclusions. Organize and format a presentation before the credit check is run:
- Provide a truthful explanation for credit scores, including catastrophic health and housing expenses.
- Explain how you handled a rough situation since that is what the investor is more interested in.
What Traits Do Angel Investors Look for?
Angel investors also look for certain traits in a business’s owner—not just the business itself:
- You’re a good listener. The angel investor will undoubtedly watch to see whether you listen to their ideas and suggestions. Many are former business owners who want to help people that are just starting out.
- You remain strong in the face of scrutiny. You should expect angel investors to do a lot of research and careful investigation into your business plan.
- You are honest. Avoid any negative tones that might impact relationships. The right approach can help the business succeed. It is important to be upfront about any concerns.
Angel investors help new small business monetize their ideas and innovations. Your income potential—not credit scores—will mainly determine if you can gain their acceptance and support. (Although, investors may also look at things like possible returns on investment, your business plan, and overall credit history as part of a comprehensive background check if they see fit.)
Although investors will likely not care about low credit scores, to minimize the impact it has on their final decision to back you, it is recommended that you disclose this information upfront and provide explanations at the appropriate time. That way, you are completely transparent, and investors will have more reason to trust you.