Behind the Scenes of Startup Funding: Angel Investor's Perspective on Investment Decision Process

Experience as an Entrepreneur and Perspective as an Investor

I am currently an angel investor in multiple companies. Having both past and present experience as an entrepreneur, along with my current perspective as an investor, has enabled me to develop a bidirectional understanding of the startup ecosystem. And right now, what entrepreneurs clearly lack is the perspective of investors who should be their partners.

In this article, I will discuss the reality of angel investment in Japan from an investor's standpoint, and the "real strategies for receiving investment" that entrepreneurs should know. In particular, I hope that entrepreneurs aiming to raise funds will understand the concept of "evaluation cost" and how to overcome it.

As a Ministry of Education Entrepreneurship Ambassador, I've noticed that there is a significant information gap in the investment world. While we often see news about large-scale funding from VCs, the reality of angel investment, which precedes this stage, is rarely discussed. Particularly, "what criteria investors use to select investment targets" remains a major black box for entrepreneurs.

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I personally consider investing a life's work, and my perspective differs from VCs who do it as their main profession. Nevertheless, I can see the investment world from an investor's viewpoint, and by sharing this perspective, I hope to bridge the information gap between startups and investors, even if just a little.

The "Evaluation Cost" Problem for Angel Investors

What is Evaluation Cost?

One of the biggest challenges in angel investing is the high "evaluation cost." "Evaluation cost" refers to the time, effort, and money investors spend to determine the value of an entrepreneur and their business. Especially for newly established companies with little track record or data, evaluation requires considerable effort.

This cost arises from what economists call "information asymmetry." While entrepreneurs fully understand their own strengths, investors have limited information, leading to high uncertainty. According to economist Michael Spence's Signaling Theory, in such situations, the party with more information (the entrepreneur) can reduce the anxiety of the party with less information (the investor) by sending signals (proof of trustworthiness)¹.

In my practice, I make investment decisions based on a single 30-60 minute meeting, and if I can't decide in one meeting, I pass on the opportunity. Moreover, I'm so strict that I decline even meeting requests that don't come through trusted acquaintances. These constraints might seem irrational at first glance, but they're actually a rational strategy to minimize evaluation costs.

Why "I Only Look at Referred Deals"

Let me explain why I only consider deals referred by acquaintances.

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Like most angel investors, I engage in investment activities as a side job while maintaining my main profession (entrepreneur/executive). This means the time I can allocate to researching investment opportunities is extremely limited. Here's where "social proof" becomes important. A recommendation from a trusted person means they have already conducted a certain level of "screening," significantly reducing my own evaluation cost.

This method has several advantages:

1. Maximizing time efficiency: The referrer functions as a primary screening filter
2. Improving information reliability: Utilizing contextual information held by the referrer
3. Reducing mismatches: Referrers tend to consider compatibility when making introductions
4. Facilitating communication: Initial trust is formed through the common connection

In information economics, referencing others' actions is called an "information cascade." In situations with high uncertainty, such as startup investments, this strategy isn't necessarily irrational—it can be an efficient decision-making approach.

Information Asymmetry and the Science of Evaluation

The information gap between entrepreneurs and investors is similar to the economic concept of the "market for lemons." Investors must make judgments based on limited information in a market where good opportunities (good lemons) and problematic ones (bad lemons) coexist.

There are two main approaches to evaluation:

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1. Independent research: Conducting detailed due diligence and making judgments based on one's own analysis
2. Social reference: Emphasizing evaluations by other investors or mentors and making decisions based on their judgments

Professional VCs (Venture Capital firms) generally take the former approach, while many angel investors adopt the latter. In my case, since my ticket size is relatively small at 1-3 million yen, it's more efficient to utilize the judgment of trusted referrers rather than conducting detailed investigations for each deal.

Investor Psychology for Reducing Evaluation Costs

Investors tend to use several psychological shortcuts to reduce evaluation costs:

1. Anchoring effect: The first information obtained (e.g., other investors' evaluations) becomes the basis for judgment
2. Confirmation bias: Preferentially accepting information that supports one's hypothesis
3. Halo effect: Tendency to evaluate the whole positively based on one good feature
4. Familiarity bias: Overvaluing familiar elements (education, career background, etc.)

Understanding these psychological tendencies is important for entrepreneurs to grasp investors' decision-making processes. For example, I can't deny that my Kyoto University background gave me an advantage in gaining initial trust. However, education alone is insufficient; track record and character ultimately determine the final judgment.

Standard Process of Angel Investment in Japan

Flow from Initial Meeting to Investment

The process of angel investment in Japan generally follows these steps²:

Initial meetings typically last about 30 minutes, and investors are said to sense "whether it's worth considering for investment" within the first few minutes. If a good impression is formed, the scheduled time might be extended on the spot, or additional meetings might be arranged.

While angel investments don't typically involve as rigorous due diligence as VC investments, simple investigations like verification of founders' backgrounds and business plans are usually conducted. Investors may request documents such as financial statements and business plans from entrepreneurs to evaluate the future potential and risks of the business.

My consideration flow is quite simple compared to other investors:

1. Receive an introduction to a deal from a referrer
2. Conduct one 30-60 minute meeting
3. Make an investment decision on the spot (continued consideration = effectively passing)

There's a reason for this ultra-efficient process. I position investment as "a front-row seat fee to experience an industry," and I'm not solely pursuing economic returns. That's why I choose not to invest in relationships with people who are difficult to communicate with or with whom I can't discuss business over a meal, even if the venture might be profitable.

Reality of Time Required for Investment Decisions and Success Rates

The period from initial meeting to contract varies greatly depending on the deal, but it typically takes several weeks to several months. Compared to VC investments, angel investments tend to be concluded in a relatively shorter period because the investment amounts are smaller.

Regarding investment success rates, the reality is that the proportion of investments that actually reach conclusion is very low. According to U.S. data, the probability of idea-stage startups successfully raising funds is only about 1-2%³. The situation is similar in Japan, and it's not uncommon for "only a few out of 100 initial meetings to result in actual investment."

This low success rate stems from both entrepreneurs' lack of preparation and investors' cautious attitude. Investors develop discernment by seeing numerous deals and try to optimally allocate their limited portfolio slots. Therefore, it's common for entrepreneurs to contact many investors and conclude contracts with only a very small number of them.

Contract Documents and Legal Aspects

When an angel investment reaches conclusion, it typically involves issuing shares through a third-party allotment capital increase. The main documents used in this process are:

1. Share Subscription Agreement (Total Number of Offering Shares Subscription Agreement): A contract between the issuing company and the investor, defining the subscription to new shares and payment amount
2. Shareholders Agreement (as needed): A contract between existing and new shareholders, determining future stock handling and management involvement
3. Articles of Incorporation Amendment/Shareholders Meeting Documents: Documents for corporate law procedures necessary for capital increase

In Japanese angel investments, the conditions are usually not as complex as VC investments, and many cases proceed with just a relatively simple subscription agreement. However, new investment schemes like J-KISS are also becoming more widespread (discussed later).

Caution is also needed from the perspective of the Financial Instruments and Exchange Act. Generally, when soliciting shares from an unspecified large number of investors rather than specific few, it falls under "public offering of securities" and in principle requires submission of securities registration statements, etc.⁴. In Japan, an exception is made for "small private placements" to "fewer than 50 investors" which don't require such filings, but even in this case, solicitation to an unspecified large number is prohibited.

Therefore, it is often legally problematic for entrepreneurs to openly solicit "please invest in our company" on the internet where anyone can see it. Even promising startups typically negotiate in a form where investors are individually introduced and limited, to avoid violating these regulations.

Angel Tax System and Latest Systems

The "Angel Tax System" is a tax incentive measure for individual investors investing in venture companies, introduced in Japan in 1997. In the 2023 tax reform, this system was significantly expanded⁵.

In the latest system, a Pre-seed/Seed Special Exception has been newly established, allowing unlimited offsetting of investment amounts in newly established companies against other capital gains. Also, a system equivalent to the Japanese version of QSBS (Qualified Small Business Stock) has been created, with a measure introduced in 2023 that exempts capital gains from the sale of startup shares from taxation up to a maximum of 2 billion yen⁶.

These tax incentives aim to reduce risks for angel investors and further promote investment in startups. Since 2022 was positioned as the "First Year of Startups," such support measures have been expanding, with a goal set to increase annual investment in startups to 10 trillion yen by fiscal 2027.

Entrepreneurs can lower the barriers to investment by understanding these systems and appealing to investors that they "meet the conditions for the Angel Tax System."

However, it should be noted that when I filed my latest tax return, dealing with angel investment targets was unexpectedly complicated and time-consuming for government responses, so it might not be worth the cost for a company to accommodate a single small investor. One should naturally consider the balance of costs when considering investment.

Signals and Criteria Investors Look At

Team Composition Evaluation

Team composition is an extremely important element in startup success. With the advent of the AI era, there are also changes in these evaluation criteria.

From the perspective of solo founder vs. co-founding team, the conventional view was that "it's better to have co-founders." This was because it was thought that founders with complementary skill sets such as technology and business could enhance business momentum by working together. However, recent research suggests different views.

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According to Wharton School research, startups with solo founders take 3.6 times longer to get on track than team-founded ones, but they tend to survive longer and generate higher revenues in the long run⁷. On the other hand, Carta's survey shows that solo founders have a lower VC fundraising success rate compared to multiple founders.

In the AI era, this dynamic is also changing. The development of generative AI has created the possibility that a single person can handle tasks that were previously divided among team members. With AI assistants being a great help in tasks such as code creation, design, and marketing strategy formulation, cases are emerging where solo entrepreneurs use AI as a "co-founder substitute."

In my investment decisions, rather than the dichotomy of solo vs. team, I emphasize the perspective of "whether they have a structure that can maximize the use of AI tools." However, it should be recognized that AI cannot completely substitute for innovation born from discussions among humans and diverse ideas.

Signaling Theory: The Role of Education, Background, and Referrals

From the perspective of economic signaling theory, signals (proof of trustworthiness) that entrepreneurs send to investors are extremely important. Especially in the early stages where information asymmetry is large, they serve to show that the person is "worthy of high evaluation."

Representative signals include:

1. High education/proof of expertise: Degrees from prestigious universities or professional certifications serve as evidence of ability and give evaluators peace of mind
2. Rich career history/achievements: Experience working at famous companies, awards received, patents obtained, etc., serve as material showing ability and reliability
3. Recommendations/introductions from others: Introductions from trusted individuals or institutions serve as "guarantors" to ease evaluators' concerns
4. Early success cases: Even small-scale initial customer acquisition or prototype success serves as proof that "they can do it if they try"
5. Sincere communication: Daily attitudes such as keeping promises and responding politely serve as signals of "trustworthy character"

In my own experience, my educational background from Kyoto University helped in gaining initial trust. At the same time, in my past entrepreneurial experience, ingenuity in customer acquisition (such as a "pay-what-you-want model") that helped put the business on track also became a powerful signal to investors.

Signals don't function in isolation but work in combination to become more persuasive. For example, even with good education and achievements, if there are communication problems, it often doesn't lead to investment.

Three Elements I Emphasize in Investment Decisions

The three elements I particularly emphasize in investment decisions are:

1. Possibility of industry re-experience

   • Can I gain new industry knowledge through the investment target?
   • Is it a field where I can learn a lot?
   • Is there value as a "front-row seat fee" beyond capital gains?

2. Communication qualities

   • Does the person have the character to discuss business over a meal together?
   • Can we build a relationship where frank discussion is possible?
   • Is there potential for building a long-term trust relationship?

3. Founder's technical literacy

   • Especially in the AI era, does the founder themselves understand technology?
   • Do they have a design philosophy and can they create a system that scales?
   • Do they have a perspective that connects technology and social problem-solving?

Based on a comprehensive judgment of these elements, I make investments with a ticket size of 1-3 million yen. Like many angel investors, I'm not solely pursuing economic returns, but rather emphasizing "what kind of learning can be obtained."

Angel investment is high-risk, high-return investment aiming for home runs, but the reality is that most deals don't bring the expected economic returns. That's why it's important to design rewards beyond capital gains (industry knowledge, human networks, learning).

Why Communication Skills Are Important

In investment decisions, the founder's communication skills are more important than you might think. There are several reasons for this:

1. Foundation for long-term relationships

   • Angel investment is a long-term game, taking at least 5-10 years until Exit (IPO or M&A)
   • During that time, cooperation with investors is needed in various situations
   • Good communication increases the possibility of support and additional support in difficult situations

2. Quality of information sharing

   • Regular sharing of business status strengthens the relationship with investors
   • Transparent reporting when problems occur encourages cooperation in problem-solving
   • The ability to properly convey both good and bad news is important

3. Persuasiveness and fundraising ability

   • Excellent communication skills increase the success rate of fundraising in the next round
   • Being able to clearly convey your company's vision and strategy gains investors' trust
   • It leads to the ability to involve team members and stakeholders

According to Harvard Business School research, 65% of startup failure causes are relationships between co-founders⁸. This indicates that communication skills directly affect business success or failure.

I myself started my first company with three people including a colleague from my previous job, but we had differing opinions on capital policy and I ended up leaving one month after corporate registration. Thanks to making the decision early, we're still in touch rather than having long-term complications.

In my experience, factors like "whether I want to work with this person" often influence the final investment decision more than technical capabilities or business model advantages. Especially when meeting time is limited, communication skills become an important indicator of personality. While being able to execute technically is important, ethical perspective is also something I highly value. I absolutely won't invest in entrepreneurs who choose zero-sum games where they profit at the expense of others' unhappiness.

Evolution and Practice of Investment Schemes

Characteristics and Usage of Investment Schemes like J-KISS

In addition to the traditional investment through common stock, new investment schemes have been spreading in recent years. A representative example is J-KISS (Japan - Keep It Simple Security).

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J-KISS is a Japanese adaptation of the KISS contract published by 500 Startups in Silicon Valley in 2014, with the first version published in 2016 by then-500 Startups Japan (now Coral Capital)⁹. It was significantly updated in 2022, with J-KISS 2.0 (Post Money version) being the latest.

The main features of J-KISS are:

1. Valuation Cap: Sets an upper limit on the company valuation to be applied at the next fundraising
2. Discount: Allocates shares at a preferential rate with the set discount rate at the next fundraising
3. No interest/maturity: Unlike regular convertible bonds, it has no debt characteristics and no repayment obligation
4. Conversion trigger: Automatically converts to shares upon events such as the next equity financing

The biggest advantage of this mechanism is the ability to postpone the determination of valuation (company value assessment). It's difficult to calculate an appropriate company value in the early startup phase, and negotiating this takes time, but with J-KISS, you can base it on "the price determined in the next funding round," streamlining the investment procedure in the early stage.

On the other hand, J-KISS also has points to be careful about, such as conversion conditions and handling between multiple investors. Also, investors have the disadvantage of not immediately obtaining shareholder rights. In fact, I personally have some reservations about convertible investment schemes like J-KISS. While they're not a problem in case of success, there have been cases around me where they become disadvantageous in failure scenarios (differences in position between shareholders and rights holders).

Also, while it's said that valuation determination can be postponed, I feel that determining cap and discount rate is nearly the same work. I think it's appropriate to apply them in cases where they enter under the same conditions, such as accelerator programs hosted by investors or companies, but I don't think entrepreneurs should actively propose J-KISS.

Relationship Between Seed Rounds and Angel Investment

Angel investment plays an important role in seed-stage financing. Generally, funding rounds progress as follows:

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The typical scale of angel investment in Japan is generally around 1-5 million yen for individual investors. For the entire seed round, many cases aim for fundraising of about 50-100 million yen.

Cooperation between angel investors and VCs is also increasing, with a common pattern being first gathering small amounts of funding from angels, then raising funds from VCs after establishing some track record. This "staged fundraising" is a rational strategy to acquire funding from appropriate investors according to the risk at each stage.

Regarding valuation in seed rounds, 1-3 billion yen might be a common level in Japan. However, this varies greatly depending on the industry, business model, and founders' track record. The progress status of products or services (completion of MVP development, acquisition of initial customers, etc.) also affects the valuation.

Risks Investors Are Concerned About and How to Address Them

Angel investors are concerned about various risks. Understanding and appropriately addressing these risks is key to securing investment.

1. Product-Market Fit (PMF) Risk

   • Concern: Unclear if there's market need for the product
   • Solution: Present market research data, collect feedback from initial customers, share verification results from MVP

2. Founding Team Risk

   • Concern: Team's lack of ability, conflicts between co-founders, departure of key persons
   • Solution: Team composition with complementary skills, clear role division, proper contracts between founders

3. Cash Depletion Risk

   • Concern: Running out of funds and being unable to continue the business
   • Solution: Clear fund usage plan, realistic fundraising plan, explanation of spending management mechanisms

4. Scalability Risk

   • Concern: Business remains a small-scale business without growing significantly
   • Solution: Explanation of growth strategy and scalable business model, presentation of large market size

5. Co-investor (Syndicate) Risk

   • Concern: Conflicts of interest with other investors, interference in the next round
   • Solution: Transparency in relationships between investors, protection of rights in shareholders agreement

What's particularly important is not hiding these risks, but honestly recognizing them and explaining countermeasures. Investors tend to evaluate risk awareness and response capabilities rather than perfect plans.

In addition to the above risk factors, what I emphasize in investment decisions is whether "the founder understands the risks and still has the determination to take on the challenge." As mentioned earlier, I value "relationships where we can talk about business together," and I feel trust in founders who can have frank dialogues about risks.

Importance of Relationship Management After Fundraising

Building relationships with investors after receiving investment is also an important element for success. Proper relationship management greatly affects the next fundraising and business growth.

1. Regular Information Sharing

   • Share progress through monthly update emails, etc.
   • Communicate both good and bad news with transparency
   • Clearly report financial status, KPIs, challenges, and countermeasures

2. Appropriate Utilization of Advice and Support

   • Actively utilize investors' knowledge and networks
   • Make specific support requests and provide feedback on results
   • Maximize learning from investors with expertise and experience

3. Preparation for the Next Round

   • Clearly define milestones to be achieved and share progress
   • Consult early about the timing and scale of the next round
   • Identify the appropriate timing to request introductions to potential new investors

If an ideal relationship can be built, angel investors become more than just fund providers—they become mentors, advisors, and supporters. I myself want to build relationships beyond mere financial relationships with the founders I invest in and support their long-term growth.

On the other hand, excessive interference or reporting obligations can become a burden for founders. It's important to discern the balance of the relationship and build a relationship that is valuable to both parties.

My personal stance is that, since I'm not a VC, I basically don't provide business advice. Conversely, as a fellow entrepreneur, I focus on empathizing with and resolving psychological issues. The entrepreneurial flame is more easily extinguished than one might think. Even the strongest entrepreneurs find it too painful to overcome many difficulties alone. I value what I understand as a fellow entrepreneur.

Conclusion: Ideal Relationship Between Entrepreneurs and Investors

Importance of "Reward Design" Beyond Capital Gains

In angel investment, relationships relying solely on economic returns are fragile. Considering the success probability of investments, I believe it's important to design "rewards" beyond capital gains. At least I emphasize this point.

I personally position investment as a "front-row seat fee to re-experience an industry." This perspective has deep meaning:

1. Opportunity for knowledge acquisition: Can learn deeply about new industries and technology trends
2. Network expansion: Can gain connections with industry experts and entrepreneurs
3. Social contribution: Satisfaction from supporting the growth of the next generation of entrepreneurs
4. Intellectual curiosity fulfillment: Can experience changes happening at the forefront of business

By designing multiple "rewards" like this, value can be obtained from the investment experience even if economic returns don't materialize. This is an important perspective for entrepreneurs as well, and presenting "non-monetary value you can obtain" to investors can increase the possibility of securing investment.

Why Building Trust Relationships Is Most Important

The essence of angel investment lies in trust relationships between people. Especially in early-stage startups, many investment decisions are based on trust in the founders.

The reasons why trust relationships are important are:

1. Long-term relationship: It normally takes 5-10 years until Exit (IPO or M&A)
2. High uncertainty: Things rarely go according to business plans, and flexible responses are needed
3. Support during difficult times: Support is needed during tight cash flow periods or business pivots

In my experience, the quality of the relationship after investment often determines the success or failure of the investment. By building a relationship where you can utilize not just funds but also investors' knowledge and networks, the probability of business success greatly increases.

Advice for Entrepreneurs Seeking Angel Investment

Finally, I'd like to offer advice to entrepreneurs considering angel investment:

1. Be conscious of "evaluation cost"

   • Understand that investors have limited time and effort to evaluate deals
   • Prepare concise and clear explanatory materials, and convey important points first
   • Approach investors through trusted referrers

2. Emit signals effectively

   • Specifically show small successful achievements, not just education and career
   • Actively utilize recommendations and support from others
   • Practice sincere communication

3. Prioritize "compatibility" with investors

   • Choose not just someone who will provide funds, but someone you can deal with long-term
   • Confirm if you can share values and vision for the business
   • Determine if you can expect support beyond funding (knowledge, networks)

4. Don't make fundraising an end in itself, but position it as a means

   • Remember that fundraising is not the goal but a means for business growth
   • Prioritize business progress and customer value creation over fundraising amount or valuation
   • Excessive fundraising may sacrifice founders' freedom and equity

Angel investment is not just a means of acquiring funds, but the beginning of a long-term partnership between entrepreneurs and investors. Sharing each other's values and goals and building a win-win relationship will be the path to true success.

References

Footnotes

1. Spence, M. (1973). Job Market Signaling. Quarterly Journal of Economics, 87(3), 355-374. ↩

2. Aikawa, Shinji. (2023). Super Easy Understanding of the Specific Flow Until Receiving "Angel Investment". DiQt. ↩

3. Sena, P. (2024). 20 Reasons Startups Fail. LinkedIn. ↩

4. Financial Services Agency. (2023). Guidelines on Public Offering or Secondary Distribution of Securities. ↩

5. Financial Services Agency. (2023). Report on Angel Tax System Reform. ↩

6. Imaeda, Soichiro. (2023). How to Achieve 10 Trillion Yen in Startup Investment by 2027. Logmi Business. ↩

7. Seedblink. (2023). The Founder Factor on Startup Success: Solo vs. Co-Founders. ↩

8. Forbes Business Council. (2022). How Solo Founders Succeed. Forbes. ↩

9. Coral Capital. (2022). We've Released J-KISS 2.0 (Post Cap J-KISS). ↩