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Angel investing is a unique investment option where high net-worth individuals provide businesses with necessary funding in exchange for equity in the business. People seek out angel investment opportunities because of the higher-than-average potential returns.
Angel investors invest in both mature companies and start-ups alike. A recent study shows that the average business that seeks out angel investors is 6 years old. Companies seek out angels because it allows them to connect with public investors while remaining a privately-held company.
Instead of receiving just a share of stock or a quarterly dividend, angel investors trade their investment for equity in the business itself. This means if the investment pays off, the angel investor collects far greater rewards than they would have with a less-risky investment.
- Angel investing carries a greater risk, so a common rule of thumb is to invest no more than 10% of your total portfolio into angel investments.
- Angel investments can range in size from $10,000 to $1,000,000.
- According to a 2020 study, angel investors contributed a total of $25.3 billion dollars to start-up companies, which is a 6% year-over-year increase.
What is an Angel Investor?
Angel investors are individuals who invest in companies in exchange for equity or convertible debt. In recent years, angel investing has expanded to include large groups of investors who each contribute a small amount in order to crowdfund a much larger investment.
Angel investors are often referred to by various names like: angel funders, seed investors, or private investors.
When angel investments pay off, they have a far higher rate of return than normal investments, but carry with it a much greater risk. Angel investors typically look for at least a 20% return, and all the way up to 60% return on their investment.
Unlike a regular investor that purchases shares of an established company with years of profitability, angel investors sometimes invest in companies in their very earliest stages.They’re referred to as “angels” because they provide capital to start-ups at a crucial stage; before they’ve released a product or even generated revenue.
This type of early-stage investment carries with it an appreciably higher risk as the start-up could fail before it ever enters the marketplace.
A Brief History of Angel Investing
The term “angel investor” was originally used to describe wealthy patrons of the arts who would invest in Broadway productions that were on the verge of failing. In 1978, William Wetzel, a professor at the University of New Hampshire used the term “angel” to describe investors who provide seed money to entrepreneurs, and the term has gained popularity since.
How Angel Investing Works
Instead of waiting for a company to be listed on the stock exchange, angel investors want to invest in a new company as soon as possible; sometimes when the business is nothing more than an idea. Angel investors typically invest after the initial seeding round of the company which may total in the low thousands of dollars.
When the angel connects with the business owners, the following stages occur.
The Discovery Phase
Angels connect with companies via professional networks, mutual colleagues, referrals, or conventions. They may hear about the business online, or on television and reach out about investing.
The Research Phase
If the founder of the company is open to investment and both parties are interested, the angel will research the company by discussing it with the founders, reviewing the business plan, and learning about the product, industry, and competitors.
The Contract Phase
If the angel decides to proceed, they’ll discuss how much they plan to invest, and what they expect in return. If this discussion is agreeable, contracts will be drawn up that clarify the offer. These details include the angel’s equity, any potential liability, and an eventual exit for the angel when the company goes public. After the contract is agreed upon and signed, the angel transfers their investment to the company.
Types of Angel Investors
Angel investors come from many different backgrounds and walks of life. They typically include active or retired C-suite executives, entrepreneurs, or high-income professionals like doctors and lawyers. These angel investors all have one thing in common, they’re all looking for a high-return on their investment, which is why they’re attracted to angel investing.
Angel investors often find investment opportunities through networking. Most angels will be networked with the company’s founders in some way. These connections include family members, close friends, or professional colleagues. Another category of angel is the “archangel investor.” Archangels are serial angel investors who are always looking for the next great business to help fund.
Sources of Funding
Angels will fund investments with their own income, or money they have earned from a previously successful investment. This is a double-edged sword because if the investment pays off, they get all of the profit to themselves, but if the investment fails, they shoulder the loss alone.
Pros & Cons of Angel Investing
Advantages of Angel Investors
Shared Knowledge and Experience
Angel investors will often have experience in the company’s industry, and be able to share their knowledge and experience with the founders. They can also use their own professional network to create business opportunities or find discounts for the company they invest in.
No Loan Repayment
If a business gets a bank loan and then fails, they are still required to repay the loan. Angel investing has a silver lining for businesses that fail, because there is no debt to repay afterward.
Future Cash Injections
When an angel believes in a business, they don’t stop with a single investment, but make multiple cash infusions, often at the most critical moments. While this results in trading away more equity to the angel, it can keep a burgeoning business afloat until it reaches profitability.
Professional Development
Angel investing allows you to work and learn alongside entrepreneurs in new industries and with cutting-edge products. You can meet and network with founders and other investors, which can lead to new business opportunities.
Diversification
Angel investing allows investments in new, emerging industries that may not be represented on the stock market. A portfolio of conservative, blue chip investments can be balanced out by angel funding.
Huge Investment Returns
The dream of owning part of the next big thing is what drives so many angel investors. For those who aren’t satisfied with single-digit returns, angel investing provides a chance to multiply their investment.
Disadvantages of Angel Investors
The High Cost of Free Money
While the business receives the investment up front, the angel investor gets paid far more down the line. Giving away 30% equity of a non-existent business is easy, but it can sting later on when the angel investor arrives to ask for a third of the now-profitable company’s stock options.
Reduced Independence
Angel investors have different personalities; some of them may want no involvement in the business, while others may want a seat on the board of directors. In the latter instance, CEOs and company founders may have to field questions and demands from an investor, when before they only answered to themselves.
Bad Advice
While every angel has money, they may not have the business know-how to help you get off the ground. Acting on advice and feedback from an inexperienced investor can result in bad decisions that may hamper a company’s progress.
Uncertainty
At the start-up stage, the company’s product may only exist as a drawing on the back of a napkin. With little to no business history, quarterly earnings, or even a completed sale, the lack of information creates a lot of uncertainty in this type of investing.
High Failure Rate
Angel funding can be a risky bet. Only 1 in 7 startups succeed, but those odds carry with them greater rewards. Many investors keep angel investing to a maximum of 10% of their portfolio to mitigate potential losses.
The Exit is Years Off
It’s rewarding when your angel investment pays off, but it could be several years before the angel actually receives their payout. Keep in mind that you may not receive your returns for several years.
How One Can Become an Angel Investor
Angel investments are typically limited to high net worth individuals, but groups of people can crowdsource an angel investment together, allowing them to be angel investors for smaller sums of money. Researching and identifying exciting new businesses that could become profitable is time-consuming, so EquityNet finds and showcases angel investing opportunities for funding groups to invest in. Sign up today and get started building your better future by investing in tomorrow.
