One of the biggest challenges to starting a small business and building it into a corporation is capital. You have to spend money to make money, and many entrepreneurs are strapped for cash. What do entrepreneurs do when private lenders, investment banks, and capital markets see their business ideas as uninvestable?
They often look to angel investors.
There are thousands of wealthy individuals who continue to build their wealth by investing in up-and-comers through angel investments. But there’s more to angel investing than meets the eye.
What Is an Angel Investor?
Angel investors are usually high-net-worth individuals who act alone or in small groups. By contrast, venture capitalists and private equity investors tend to operate within larger firms. Angel investors invest in new businesses and the entrepreneurs who operate them in exchange for an equity share in the business.
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In most cases, these investors target small, early-stage startups that lenders, investment banks, and capital markets wouldn’t invest in. The targets are usually small companies with little to no revenue. Some don’t even have a product on the market yet. Angel investments typically range from $25,000 to $100,000, but there are no rules that stipulate a minimum or maximum investment required.
How Angel Investing Works
An angel investor invests in early-stage, high-risk companies — the types of companies banks and the general investing public wouldn’t touch. They make investments with their own money.
Most angels previously enjoyed successful careers as entrepreneurs or corporate executives. The angel’s wealth is a result of their success, and they use that wealth to help others achieve their business goals.
Looking for New Investment Targets
When they decide they’d like to become angels, they usually start by joining an angel investor website or group. As group members, they’re presented with multiple investment opportunities to choose from. A common place to start is the Angel Capital Association’s directory of more than 250 Angel groups.
Next, the angels do their due diligence. This process usually starts by reading the prospects’ business plans and deciding which plans are most appealing. Once the investors boil their options down to just a few, the real due diligence process starts.
Approaching Investment Targets
The investors typically reach out to the businesses they’re interested in to get to know the entrepreneurs or management teams behind them. They also assess the market size for the product or service the company produces, the stage of business the company is in, the competition in the industry, and other factors that help them assess the quality of the investment.
Navigating the Negotiation Process
When the angels are satisfied with the business startups they’ll back, the negotiation process starts. Although angel investors have the word angel in their name, they’re still investors, and their ultimate goal is to make money.
The angels negotiate what they believe to be a fair market valuation and the terms of the investments. The negotiations usually include two key factors:
- The Investment Amount. Angel investments typically range from $25,000 to $100,000 but can be higher or lower. The angel works with the entrepreneur or management team to determine how much money is necessary for the company to meet its goals.
- The Equity Amount. The angel expects an equity stake in exchange for the startup cash they provide. They typically seek to buy between 20% and 25% of the equity in the company, but the amount of equity isn’t set in stone until the parties sign a final agreement.
Executing the Agreement
Once the agreement is signed, the deal is final. The angel pays the entrepreneur or business the seed money they need to grow. However, the money may not come directly from the investor. In many cases, the money is paid through an investment fund, trust, or business. High-net-worth investors tend to do business through various entities for tax purposes.
In most cases, the angel investor’s work is done as soon as the money is transferred. The investment becomes a passive one, and the angel patiently waits for the business to grow. However, in some cases, angels take more active roles in the companies they support. Some may offer monthly mentoring and coaching, while others may stand by the entrepreneur’s side weekly to help improve operations.
More recently, innovation has led to a new form of angel investing: crowdfunding. Angel investors are now teaming up on equity crowdfunding platforms to find new and exciting investment opportunities. However, many of the more successful angel investors still prefer the traditional way to go about the process.
Angel Investor Qualifications
The only real qualification required to be an angel investor is to have enough money to make investments. Angel investors invest their own money and have no fiduciary responsibilities to others. If you’ve got $25,000 or more to invest in a single startup, you can be an angel. However, the most successful angel investors are usually:
- Accredited Investors. Most angels are accredited investors according to the Security and Exchange Commission’s (SEC’s) definition. Accredited investors either have a net worth of more than $1 million or have earned at least $200,000 per year for the past two consecutive years. That said, angel investors aren’t required by law or regulation to be accredited. Equity crowdfunding websites make it possible for the average Joe to make small angel investments.
- Experienced. Most angels have built their wealth through hard work and wise investments. The life experience they’ve earned over the years is invaluable as they embark on their angel investing journeys.
- Good Researchers. The most successful angel investors perform deep research on the companies they invest in and the markets and audiences they serve. They have a knack for numbers and have a good sense of whether a particular company has real potential.
Angel investors and venture capitalists have several similarities.
They both invest in private companies in exchange for equity. They also both focus their efforts on startups and take risks on companies that the lending and investing communities find too risky to get involved in. Ultimately, they both provide the financial lifelines early companies need to make growth happen.
They’re also very different. These factors set them apart:
- Investment Size. Angel investors typically invest between $25,000 and $100,000 in the companies they support. The average venture capital investment is around $7 million.
- The Money Being Invested. Angels invest their own money into the companies and entrepreneurs they believe in. VCs are part of investment funds that pool money from high-net-worth individuals, insurance companies, and other institutional investors to build their portfolios.
- The Business Stage. There are several stages of business development, and angels tend to invest in the earliest stages of development. The companies they back are often working toward intellectual property and product development, but they don’t have anything on the market quite yet and aren’t earning much if any revenue. Venture capitalists are usually interested in companies that have intellectual property and products in place and have moved into the commercialization stage.
- Research. Although angel investors are known for doing their own due diligence, there’s usually far more research and fact-checking involved in venture capital investments. That’s because the venture capital firm has a fiduciary responsibility to act in the best interest of the investors it serves. The only way to do so is with adequate research.
- Active vs. Passive. Some angels are active investors that take a part in the companies they invest in, but the majority are passive. Venture capitalists are almost always hands-on with the businesses they invest in, often taking seats on boards of directors and pushing their own growth agenda.
How to Become an Angel Investor
If you’re not an accredited investor, it’s better to make traditional investments in stocks, bonds, and other securities.
If you are an accredited investor and would like to start angel investing, you have three options to find new business ventures to back:
- Crowdfunding Websites. Join crowdfunding websites for angel investors and look for opportunities that pique your interest.
- Join an Angel Investor Group. The largest angel investor group is the Angel Capital Association (ACA). These groups pair angels with startups that need financial backing.
- Networking. Join business circles and groups both in real life and on social media. Talk to local business owners about opportunities in your area and build a network of your own.
Simply join a group or crowdfunding website and start looking for investment opportunities. As you do, remember that research is always the foundation of wise investment decisions. Learn everything you can about the companies you back before you invest in them.
Angel Investor FAQs
Angel investing is an interesting topic. These investors help entrepreneurs make their dreams come true, and they make money while they’re doing it.
But it isn’t as straightforward as it might seem. These are some of the most common questions people ask about angel investing.
Why Are Angel Investors Important?
Angel investors invest in companies that most other investors won’t touch. These companies are even too small to pique the interest of venture capitalists, but they’re still an important part of the U.S. economy.
Several major companies you work with today wouldn’t exist if there was no such thing as angel investing. For example, Facebook (now Meta), Google, and Amazon all raised money from angel investors.
What Are the Benefits of Angel Investing?
The two biggest benefits of angel investing include:
- Returns. Angel investors who make the right moves generate a high rate of return because they buy into companies when they’re small. In fact, PayPal cofounder Peter Thiel and LinkedIn cofounder Reid Hoffman both invested in Meta in its beginning stages and generated massive profits as a result.
- The Feel Good Effect. Angels don’t just back companies, they back the entrepreneurs behind them. In many cases, their investments literally make these entrepreneurs’ dreams come true.
What Are the Risks of Becoming an Angel Investor?
Any time you invest, you’re going to have to accept at least a small level of risk. That risk grows dramatically when you invest in young startup companies. Some of the biggest risks associated with angel investing include:
- Company Failure. Some companies won’t succeed no matter how much money investors back them with. If you’re an angel investor in a company that fails, you could lose your entire investment.
- Liquidity. Equity investments in early-stage companies are illiquid investments. If you make an angel investment, chances are you’re not going to recoup your funds for at least a few years. Moreover, since most investors wouldn’t touch these investments, you often can’t sell off your shares when you think it’s time to exit.
How Do You Find an Angel Investor?
If you’re a business owner who’s seeking an angel investment, follow these steps to get the process rolling:
- Write a Business Plan. Your business plan should make it easy for the investors who read it to understand exactly what your business does and what you plan to do to grow it.
- Reach Out to Angel Groups. Groups like the ACA, AngelList Venture, and Angel Investment Network are all on a mission to connect startup owners and entrepreneurs with angel funding. Reach out to these groups to learn how they can connect you to an angel.
- Social Media. You can also find angel investors on popular social networks like Facebook, LinkedIn, and Twitter. Send a few seed messages and – with a little luck – you’ll get a response.
Where Did the Term “Angel Investor” Come From?
Angel investing can be traced back to the early days of Broadway plays. People who invested money to bring the plays to life were known as angels. However, the term “angel investor” was first used by William Wetzel, the founder of the Center for Venture Research at the University of New Hampshire.
Angel investors make money by backing early-stage companies. To the founders of those companies, they are truly angels. They make it possible for entrepreneurs who are repeatedly told “no” by investment banks to follow their dreams and bring their products and services to the market.
Though angel investing has its ups and downs, those who are successful in the space earn returns far above what you would expect from traditional investment methods.
If you plan to try your hand at angel investing, always remember that research is key. Learn everything you can about the companies you’re interested in, the markets they live in, and the opportunities they present before making an investment.