Angel Investors: Who They Are, Pros and Cons

Angel investors are typically high net worth people who fund startups or early-stage businesses in exchange for stock or ownership in that company. This makes them a good source of funds for newer businesses that want to avoid taking out a small-business loan.

Many angel investors are accredited investors, which is a designation that requires a minimum net worth of $1 million, at least $200,000 in annual individual income or at least $300,000 in annual joint income (see the Securities and Exchange Commission website for details). People who hold a Series 7 license (a broker license), a Series 65 license (an investment advisor license) or a Series 82 license (a private securities offerings license) may also qualify.

Angel investors can be friends, family, members of your professional or social networks, individuals or a team of investors. Angel investors often form “angel groups,” in which they evaluate businesses and invest together, pooling resources to make larger investments. Angel investments can be thousands to millions of dollars, depending on business size and ownership sold.

Angel investors typically want ownership in the company they invest in, making this a form of equity financing. An angel investor may provide capital in exchange for equity (stock in the company) or convertible debt, which is a loan that can be converted to equity at a later date.

For example, a company that's valued at $1 million might sell 20% of its equity, worth $200,000, to an angel investor or an angel group.

Generally, angel investors are interested in high-growth, high-potential startups that can earn them several times their original investment. In other words, the potential rewards need to be substantial enough to outweigh the numerous risks of investing in a startup.

Advantages of angel investors

• Expertise. Angel investors often have industry expertise. They may be entrepreneurs who started a business in your field and can provide advice and coaching to help you succeed.

• Connections. Angel investors may have a lot of industry connections. They may be able to introduce you to new customers, financing sources, business partners and other relevant contacts.

• Support. Because their investment makes them partial owners of the business, angel investors typically make money only if the business is successful. This position should motivate them to help add as much value as possible.

• Deep pockets. If your small business needs financing later, angel investors might make follow-up investments.

• Different qualification requirements. Angel investors look primarily at you and your business’s potential, which means they are a good alternative funding source if your business can’t get financing from a bank or financial institution.

Disadvantages of angel investors

• Scrutiny. Investing in a startup is risky, and angel investors are typically looking for a high-growth type of business. Even if you think your company offers outstanding growth potential or a game-changing product, angel investors still might reject your pitch. 

• Shared control. Some angel investors might demand a large ownership position, and you may end up selling more of the company than you had planned.

• Time consuming. Do due diligence on an angel investor to ensure their interests are aligned with yours. Ask for references and, if possible, talk with other startups that raised money from this investor. You may prefer an angel investor who will be a business partner, help your company grow and contribute to its success, instead of one who's just looking for a return on their investment.

Startups and early-stage businesses that can be scaled for growth are generally the most attractive angel investments. This means your business should be able to increase its sales very quickly over the next few years without a huge increase in fixed costs and expenses. This should be detailed for a potential investor in components of your business plan, like financial projections and market analysis.

If you’re willing to give up ownership and potentially control of your company — and think you’d benefit from bringing an experienced investor on board — then angel investors could be a smart move.

You can find potential angel investors in places like these:

• The Angel Capital Association, which is the official industry alliance of over 250 of the largest angel investor groups in the United States.

• AngelList, which helps match founders with investors.

• Gust, which evaluates various funding sources for startups.

• MicroVentures, an investment bank offering private market investments.

• The Angel Resource Institute, a nonprofit that provides education and information on the best practices in the field of angel investing.

If you’re having trouble finding an angel investor, or you decide angel investing isn’t right for your business, there are some alternatives:

• Startup business loans. Banks, online lenders or alternative lenders like community development financial institutions (CDFIs) may offer startup business loans, especially if you have been operating already. Loans can be difficult to qualify for and keep you locked in with fixed payments over a set period of time, but do not require you to trade ownership in your business for funding.  

• Startup business grants. While grants offer free money, they can also be difficult to find and qualify for, and come in smaller amounts than loans or angel investments.  

• Venture capital. Though similar to angel investing, venture capital (VC) is early-stage business funding by a firm or company as opposed to a wealthy individual. Venture capital can be slightly more difficult to qualify for, and usually VC firms invest in a company after an angel investor. 

• Equity crowdfunding. Another form of equity financing whereby you trade equity or ownership in your company for funding, equity crowdfunding makes use of the internet to find groups of investors. Online platforms allow business owners to share information about their business with potential investors.