What Is Angel Investing And How Does It Work
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Introduction
What is angel investing and how does it work? Learn about it in this article.
Despite the risk involved and the satisfaction that comes from supporting a startup, angel investing may be worthwhile.
Did you notice a novel new business concept? If you look over it, you might be able to become an angel investor. In addition to helping a young startup, you can also invest early in a business you believe has a lot of potential for growth.
What is an Angel Investor?
A high-net-worth individual who supports small startups or entrepreneurs financially is known as an angel investor (also referred to as a private investor, seed investor, or angel funder). This person typically does so in exchange for ownership equity in the startup or entrepreneur.
Frequently, an entrepreneur’s family and friends will act as his or her angel investors. The money that angel investors contribute may be a one-time sum to kickstart the company or a steady infusion to help it get through its challenging early years.
Angel investors are people who want to make investments in startups in their early stages. These risky investments typically make up no more than 10% of an angel investor’s overall portfolio.
Most angel investors have extra money on hand and are seeking investment opportunities that will yield higher returns than those offered by conventional investment opportunities.
Since they frequently invest in the entrepreneur starting the business rather than its viability, angel investors offer more favourable terms than other lenders.
Instead of concentrating on the potential profit they might make from the business, angel investors help startups take their first steps. Angel investors are essentially the antithesis of venture capitalists.
Angel funders, private investors, private angels, business angels, and informal investors are other names for angel investors.
These are usually well-off people who provide startup capital in exchange for ownership equity or convertible debt. Some angel investors use online platforms for crowdfunding or create networks of other angel investors to pool their funds.
The History of Angel Investors
The term “angel” originated in the Broadway theater, where affluent patrons donated cash to support theatrical productions.
William Wetzel, the founder of the Center for Venture Research at the University of New Hampshire, coined the phrase “angel investor” first. Wetzel completed a study on the methods used by entrepreneurs to raise money.
What is Angel Investing and How Does it Work
High net worth investors engage in angel investing, a subset of private equity investing, in an effort to increase returns by assuming greater risk in comparison to investing in the public markets.
Angel investors typically provide very early funding for new businesses. These companies frequently only have a strong business plan, have finished a beta test, or have developed a minimum viable product; they may not even have customers or make any money.
Angel investor capital is frequently used for R&D, to assist with the development of the company’s product and service offerings, to create a business strategy, or to pinpoint its target market.
Venture capitalists frequently come into the picture at this point to provide the next round of funding as the business expands and scales its production, operations, and marketing.
To qualify as an angel investor, there is no set investment amount or size. The amount could range from $5,000 to millions of dollars. Simply put, it depends on the circumstance.
In exchange for the capital investment, the startup typically gives the angel investor a predetermined number of shares or the option to purchase additional shares in the future.
Depending on the startup’s funding requirements, an angel investor might support it with a one-time investment or ongoing capital contributions.
Pros and Cons of Angel Investors
Pros of Angel Investors
Having an angel investor means that your company won’t have to pay back the money because you’re exchanging ownership shares for cash. Angel funding is typically only given to companies that have passed the startup stage.
These businesses have shown signs of profitability, but they still require funding to expand or develop new products. An angel may be very motivated to support your success through mentoring or by providing specific management assistance because their financial interests are at stake.
Other benefits of angel investors as compared to other business fundings are the following:
- Speed of approval: Institutional investors, shareholders, and board members do not burden angel investors. Through the approval and due diligence stages, they frequently move quickly.
- Access to experience: If an angel investor is willing to invest in your company, it is likely that they have in-depth knowledge of your industry. You can benefit from that information because the angel investor can offer more than just financial support.
- Personal involvement: Because they are investing their own money, the angel investor has a financial stake in the success of your company. They’ll work to make sure your company is successful.
- Cash access: Angel investment can be provided as a lump sum, which is excellent for accelerating the expansion of your company. The likelihood of spreading out other types of investment is higher.
- Independence: Angel investors typically don’t want control over future funding or board seats. The majority of them favor a more straightforward structure, like capital in exchange for equity. Compared to venture capital investors, they frequently take a “hands-off” approach, giving you more freedom.
Cons of Angel Investors
The fact that angel investors typically demand 10% to 50% of your business in exchange for funding is a significant drawback.
This means that if the angel investors decide the business owners are preventing the company from succeeding, they could lose control of their company. It’s critical to consider how much equity you want to give an investor in exchange for funding because if you give too much, if things don’t work out, the angel investor may end up owning more of the company than you do.
Other drawbacks of angel investors as compared to other business fundings are the following:
- Loss of equity: If you receive angel funding, your business may no longer be entirely yours. In exchange for their investment capital, the investor will want a piece of your company, and it may be a sizable piece. Before beginning negotiations, seek independent advice to determine what is reasonable and establish your boundaries.
- Loss of control: You might lose some control even though you won’t likely be as marginalized as you might be with venture capital funding. In extreme circumstances, the angel investor might even fire you at a later time. Everything depends on how the deal is set up.
- Pressure to perform: From the perspective of the angel investor, they have given you money and expect it back along with interest. Be prepared for your company to be closely watched, and for detailed metrics analysis. High expectations from others can motivate you to work more diligently and creatively, so this isn’t always a bad thing.
Who Is Eligible to Invest as an Angel Investor?
Angel investors typically qualify as “accredited investors,” though this is not a requirement.
A person is considered a “accredited investor” by the Securities and Exchange Commission (SEC) if they have a net worth of $1 million or more (excluding personal residences), $200k in annual income, or $300k for married couples. On the other hand, being a qualified investor is not the same as being an angel investor.
In essence, these people are motivated and have the resources to fund startups. Cash-strapped startups are happy about this because they find angel investors to be much more appealing than other, predatorier types of funding.
Sources of Funding as an Angel Investor
Unlike venture capitalists, who handle the pooled funds from many other investors and place them in a carefully managed fund, angel investors typically use their own money.
Although angel investors frequently act as individuals, the actual source of the funds may, among many other types of entities, be a limited liability company (LLC), a business, a trust, or an investment fund.
Investment Profile of an Angel Investor
Angel investors who fund startups that fail in the beginning completely forfeit their investment. Due to this, seasoned angel investors seek out opportunities for acquisitions, IPOs, or initial public offerings with a clear exit strategy (IPOs).
For angel investors, a successful portfolio has an effective internal rate of return of about 22%.
Even though this may seem like a good investment to investors and too expensive to entrepreneurs with startup companies, such business ventures rarely have access to cheaper sources of funding like banks.
Angel investments are thus ideal for business owners who are still experiencing financial hardship as they launch their ventures.
Over the past few decades, angel investing has expanded as the allure of profitability has made it possible for it to become a key source of funding for many startups. This has encouraged innovation, which leads to economic growth.
How To Become An Angel Investor
1. Check your qualifications
To become an angel investor, you typically need to meet the requirements for accredited investors.
This means that either your earned income for the previous two years had to be $200,000 or more ($300,000 with a spouse), or you had to have a net worth of at least $1 million in investable assets, whether you were single or had a spouse.
Why are there limitations? Accredited investors are likely more financially prepared to handle a loss should one occur since angel investments are regarded as high-risk. Others may accept non-accredited investors, but many startups may only be able to raise money from accredited investors.
2. Learn how to find deals
In their respective fields of specialization, many angel investors have a well-established network of startup founders and business owners. They frequently interact with these connections, which allows them to learn about new startups and find deals to take into account.
When an experienced angel investor decides to invest money in a project, they can also organize and manage an angel syndicate, in which a number of angel investors pool their money to support a specific project.
If you don’t have access to this kind of network, you can get in touch with a startup’s founder directly if you find a company that has a novel business idea that you’d like to investigate and perhaps invest in.
As a member of an angel group, you can access a network of angel investors who evaluate and fund startup ventures collectively, which is another way to find deals.
You can look up an angel investing group to join using the Angel Capital Association’s member directory, and the organization’s website also provides guidance on how to launch your own group.
Different angel investment opportunities are highlighted by other organizations like Funding Post, AngelList, Microventures, and Angelsoft.
The amount of your capital investment and corresponding share of company ownership must be negotiated after you find a deal, so you must conduct due diligence.
How Much Do Angel Investors Want in Percentage?
An angel investor will expect a higher return on investment the more money they invest in your company (ROI). The expected return on investment varies depending on the type of investment and the angel investor. An angel investor frequently anticipates a 30% return on their investment.
As part of their exit strategy, angel investors will have a return on investment expectation in mind. In order to recover their initial investment and any profits, they now sell their company equity.
Be aware that venture capitalist funding will come with higher ROI expectations. These businesses will desire a higher percentage of profit because they are providing a lot more money.
How to Choose the Right Angel Investor
Approaching an angel investor who specializes in funding engineering companies makes little sense if you own a retail business.
In order for them to comprehend and relate to your business proposition, find someone who is familiar with your market.
But keep in mind that an investment agreement involves both parties. Be sure to enjoy working with any angel investors you speak with:
- Verify their references thoroughly.
- Verify that they are not already investing in one of your rivals.
- Could you collaborate with them? Conflicting personalities can cause issues.
- Look into the performance of their prior investments.
- Is their intended level of business involvement acceptable to you?
- Do they have a track record of enduring hardship to remain loyal to companies?
- Do they have helpful connections for potential business partners and investors?
How to Make a Deal with an Angel Investor
Here are some crucial factors to take into account when working with angel investors:
- Prepare your presentation in advance: Your “elevator pitch” will serve you well in this situation. Work on your clarity and ability to summarize your business plan, including projected costs and revenues, in under a minute.
- Identify the amount you require and why: Refrain from pulling arbitrary numbers from thin air. Give an example: “We need $100k because we want to open three new stores; we can cover the rent, but we need capital funding for fit-out and stock; this spreadsheet shows the numbers in detail, with projections over three, six, and twelve months.”
- Be direct: Any errors in your presentation will probably be picked up on by angel investors. If you are hiding crucial information, they will be able to tell. As a result, don’t because due diligence will reveal everything. Because no strategy is foolproof, be open about your business plan’s flaws.
- Be ready for scrutiny: Nobody enjoys dispensing cash. Every premise you make will be looked at closely and challenged. The angel investor will verify the validity of your business plan both formally and through due diligence. Please don’t take offense, but instead be prepared to field many inquiries.
- Negotiate terms: It is your company, your concept, and your vision. So, don’t divulge everything. In order to launch your company, you will have to accept a small amount of ownership or control loss. Everything is negotiable, including ownership percentage, investment type, share class, intellectual property protection, and anti-competition clauses.
Why Consider Becoming an Angel Investor
Higher risk typically translates into higher potential rewards with most investments. Angel investors seek high returns because they take on such high risk. Angel investors may be able to earn up to a hundred times their initial investment if their investment is successful.
Final Thoughts
Not every business should consider an angel investment. It may not be for you if you don’t want to cede any ownership.
However, compared to some of the more conventional types of business investment, like bank loans and venture capital, angel funding may ultimately be easier and less expensive.
Before signing any contracts, make sure to research them thoroughly. You should also seek legal and financial advice before deciding to become an angel investor.
Make the most of your angel funding once it is established. Since they want to see a positive return on their investment, the majority of angel investors actively participate in the businesses they choose to invest in. So you’ve gained a mentor in addition to financial support for your company.
Pained by financial indecision? Want to invest with Adam?
Adam is an internationally recognised author on financial matters with over 830million answer views on Quora, a widely sold book on Amazon, and a contributor on Forbes.
