Angel Investing: What It Is and How to Start
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A creative new business idea caught your eye? Perhaps you can become an angel looking over it — an angel investor, that is. Not only will you provide support for a budding startup, but you can also get in on the ground floor of a company that you think has high growth potential.
What is an angel investor?
Angel, or “seed” investors, are wealthy individuals who invest their own capital into startup companies during early stages of development, receiving an ownership stake in return.
Angel investors provide up to 90% of outside equity raised by startups (excluding friends and family), according to the Angel Capital Association, the largest angel professional development organization in the world. Entrepreneurs rely on the support of angel investors to help get their business concept off the ground.
» Seeking financing? Learn about the pros and cons of having angel investors
Angel investors can be accomplished entrepreneurs themselves, and may have expertise or experience in the industry they’re investing in. They can bring guidance, networking and knowledge to the startup company in addition to their capital investment.
Besides nurturing startups and new business ideas, angel investors are also looking for their investment to grow and pay off significantly down the road. This means they may keep close tabs on the startup’s affairs and become involved in decision-making to ensure their invested capital is used appropriately.
How angel investing works
Angel investing is a type of private equity investing, in which high net worth investors attempt to earn higher returns by taking on more risk compared with investing in the public markets.
Angel investors typically finance a business startup at the very early stages. Often, these businesses might not even have customers or generate any revenue at all — they may have only a solid business plan, completed a beta test or built a minimum viable product. Capital from angel investors is frequently used for research and development, to help the company formulate its product and service offering, to design a business strategy or identify its target market.
As the business grows and scales its production, operations and marketing, venture capitalists often enter the picture at this point to provide the next round of funding.
There is no set investment minimum or size to be an angel investor. The amount might be $5,000, or it could climb to millions of dollars. It just depends on the opportunity. The startup usually gives the angel investor a certain number of shares, or the right to buy shares at a later time, in exchange for the capital investment.
An angel investor could support the startup with a one-time investment or ongoing capital contributions, depending on the company’s financing needs.
How to become an angel investor
Make sure you’re qualified
Usually, meeting the standards of being an accredited investor is a prerequisite for becoming an angel investor. This means that your earned income must be $200,000 or more for the past two years ($300,000 with a spouse) or your net worth, alone or with a spouse, must surpass $1 million in investable assets.
Why the restriction? Angel investments are considered high-risk, and accredited investors are likely better equipped financially to handle a loss should one arise. Many startups may secure funding only from accredited investors, but others may accept nonaccredited investors.
Know how to source deals
Many angel investors have an established network of startup founders and entrepreneurs within their industry of expertise. Since they interact with these connections frequently, they often hear about new startups and can source deals to consider.
When a seasoned angel investor decides to fund a venture, they can also put together and lead an angel syndicate, where a group of angel investors collectively fund a particular deal.
If you don’t have access to this type of network, you can reach out to a startup founder directly if you come across a company with an interesting new business concept that you’d like to explore and potentially invest in.
Another way to find deals is to participate in an angel group, which allows you to tap into a community of angel investors who assess and invest in startup ventures together. The Angel Capital Association’s member directory can help you locate a group to join, and its website shares information on how to start your own angel investing group as well. There are other organizations such as Funding Post, AngelList, Microventures and Angelsoft that showcase various angel investment opportunities.
Once you find a deal, you’ll need to do due diligence before negotiating the amount of your capital investment and corresponding share of company ownership.
Why consider angel investing
With most investments, higher risk generally means higher potential rewards. Since angel investors take on such high risk, they seek high returns. If their investment works out, angel investors could potentially earn 100 times their initial investment or even more, according to the Corporate Finance Institute, a provider of online financial education and certifications.
» Want a tax break? See if your investment is a qualified small-business stock
Portfolio diversification is another reason why angel investing can be compelling. Investing in early-stage private companies has a different risk and return trade-off compared with investing in traditional stocks and bonds.
Angel investors, especially those who are entrepreneurs themselves, may enjoy being involved in new industry developments and want to boost startups with ideas they approve of and hope come into fruition.
Risks to keep in mind
Angel investing can be risky since the investments or businesses are unproven. According to FundersClub, an online investing forum for startups, 75% to 90% of startups fail. While making money is possible, many angel investors lose their entire investment.
This is why experienced angel investors frequently make investments in multiple startups throughout various industries — this helps to spread risk. Because the return on a successful investment is high, one win can more than offset the cost of the other failed ventures.
Angel investing isn’t a way to get rich quickly. For the startup to grow to the point where investors can make a rewarding exit, it can take seven to 10 years or more. It’s important to invest only money you won’t need to use in the near future, but also money you’re not too scared to lose.
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