What is an Angel Investor?

What is an Angel Investor?

Angel investors are wealthy private investors focused on financing small business ventures in exchange for equity. Unlike a venture capital firm that uses an investment fund, angels use their own net worth. Compared to venture capitalists, angels may also be more patient with entrepreneurs and open to providing smaller dollar amounts for a longer time period.

But they do want to see an exit strategy at some point where they can pocket their profits, typically through a public offering or an acquisition.

Angel investors fund businesses in many industries. According to the Center for Venture Research at the University of New Hampshire, 2020 was the first time in several years that angel-funded businesses were in the seed and startup stage. The total investments during that year were $25.3 billion – a 6% increase over 2019.

introduction of Angel investors

Angel investors are individuals who seek to invest at the early stages of startups. These types of investments are risky and usually do not represent more than 10% of the angel investor’s portfolio. Most angel investors have excess funds available and are looking for a higher rate of return than those provided by traditional investment opportunities.

Angel investors provide more favorable terms compared to other lenders, since they usually invest in the entrepreneur starting the business rather than the viability of the business. Angel investors are focused on helping startups take their first steps, rather than the possible profit they may get from the business. Essentially, angel investors are the opposite of venture capitalists.

Angel investors are also called informal investors, angel funders, private investors, seed investors or business angels. These are individuals, normally affluent, who inject capital for startups in exchange for ownership equity or convertible debt. Some angel investors invest through crowdfunding platforms online or build angel investor networks to pool capital together.

How Angel Investing Works

Angel investors prefer to get involved in the early stage of a company, at the “seed” or “angel” funding phase. That could mean the angel invests when the company exists only as an idea, or it could come when a business is already up and running.

Sometimes angel investors arrive on the scene after the initial round of funding, which normally comes from the founders themselves, friends and family of the founders or from bank financing. Typically, initial business funding isn’t substantial—it’s common for founders to roll out their product or service with $10,000 or so in initial funding.

Angel investors come in after the original funding is in place but typically before a company requires a more sizable investment from a venture capital company. Their investment is needed to grow a company at a critical (and usually early) stage of development, after the initial funding threatens to run out and before venture capital groups show interest in partnering with a promising business.

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Here’s how the actual investment process rolls out:

  • Angel investors connect with young, developing companies through word of mouth, through business and industry seminars or conventions, through referrals from professional investment organizations, from online business forums or via local events like chamber of commerce meetings.
  • If there’s mutual interest, the angel investor will conduct due diligence on the young company by talking to the founders, reviewing business investment documents and gauging the industry the company is targeting.
  • Once a verbal agreement between an angel is in place, a term sheet or contract is drawn up, with agreements on the investment terms, payouts or equity percentages, investor rights and protections, governance and control parameters and an eventual exit strategy for the angel investor.
  • Once the contract is finalized an actual legal agreement is created and signed, the deal is officially closed and the investment funds are released for the company’s use.

While contribution amounts vary, funding levels can be as low as $5,000 and as high as $150,000. Some angel investors group together as a syndicate and can provide funding up to $1 million for select companies.

Angel investors don’t usually acquire more than a 25% stake in a company. Veteran angel funders know that the company founders need to hold the highest stake in their own companies as they then also have the highest incentive to make their companies successful.

Origin of the Angel Investor

The term “Angel” originated from the Broadway theater, where affluent individuals provided money for theatrical productions. The wealthy individuals provided funds that were paid back in full plus interest once the productions started generating revenue.

The founder of the Centre for Venture Research and also a professor at the University of New Hampshire, William Wetzel, coined the term “Angel Investor” in 1978 after completing a study on how entrepreneurs raised capital for businesses. He used the term to describe investors who supported start-up businesses with seed capital.

Silicon Valley is the home of modern angel investors and also home to the largest number of start-ups in the United States. Silicon Valley received 39% of all the $7.5 billion investments in the United States-based companies in Quarter 2 of 2011. Total funding reached $22.5 billion in 2011, $2.4 billion more than the investments in 2010.

With platforms like AngelList, start-up companies can pitch directly to potential angel investors and secure funding for their business. Also, there are dozens of boot camps and conferences every year where entrepreneurs meet with investors one-on-one and pitch their ideas.

Contrary to popular belief, most angel investors are not millionaires. There are angel investors who earn $60,000 to $100,000. Some are retired entrepreneurs, doctors, lawyers, and successful people in business looking for ways to stay updated with the happenings of the business and earn an income on the side. Furthermore, they make use of their entrepreneurial skills, experience, and networks to help new entrepreneurs launch their business.

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Unlike venture capitalists, angel investors do not solely rely on monetary returns for motivation. They are motivated by the persistence of young entrepreneurs to succeed and build an empire for themselves and hope the money will follow.

Who Can Be an Angel Investor?

Angel investors are normally individuals who have gained “accredited investor” status but this isn’t a prerequisite.

The Securities and Exchange Commission (SEC) defines an “accredited investor” as one with a net worth of $1M in assets or more (excluding personal residences), or having earned $200k in income for the previous two years, or having a combined income of $300k for married couples. Conversely, being an accredited investor is not synonymous with being an angel investor.

Essentially these individuals both have the finances and desire to provide funding for startups. This is welcomed by cash-hungry startups who find angel investors to be far more appealing than other, more predatory, forms of funding.

What Percentage Do Angel Investors Want?

The more money an angel investor gives your business, they more they’ll expect a bigger return on investment (ROI). The ROI expectation varies between angels and the specific investing opportunity. It’s not uncommon for an angel investor to expect a 30% return on their money.

Angel investors will have a ROI expectation in mind as part of their exit strategy. This is the point in time when they sell their equity in the company to make up their initial investment and any profits.

Be aware that funding from venture capitalists will have a higher expectation for ROI. Because these kinds of firms are giving significantly more money, they’ll want to have a larger percentage of profit.

University of New Hampshire Center for Venture Research, “The Angel Market in 2020: Return of the Seed and Start-Up Stage Market for Angels”

 Money Morning, “Why You Need an Angel Investor Exit Strategy Before You Invest”

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Advantages and Disadvantages of Angel Investing

There are several reasons why emerging startup companies might partner with an angel investor.

Angel Investor Advantages

  • No obligations. Because they haven’t applied for a new line of credit and most angel investing involves equity deals, business owners don’t have to pay the angel funder back if the company goes belly up.
  • An angel investor is usually an entrepreneur, too. Angel investors often have an abundance of business knowledge and experience. “Especially valuable are financial backers who have established effective organizations on their own,” says Garett Polanco, an accredited angel investor who’s funded 29 companies.
  • Less administrative work. Organizations that raise financing from angels are free from onerous investment filings with the U.S. Security and Exchange Commission (SEC) and state regulators that they might have to if they decided to hold, for example, an IPO to raise money.
  • More cash down the line. When angels fund a company, they’re often in for the long haul. “They often make another cash injection later on,” says Polanco.
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Angel Investor Disadvantages

  • Less control. Companies who work with angel partners may need to give up some amount of equity in their business. While that’s normally a small amount, angel financial backers may decide they want a bigger role in business decisions.
  • A hit in the pocketbook. Angel investors require compensation for their funding. “That typically comes in the form of equity, which could be more expensive than debt financing,” Lavinsky says.
  • Potential for novice investors. A big con of taking on angel investing is winding up with an inexperienced angel investor who offers poor advice or who hounds business owners for status updates. That can especially be the case with new angel funders who steer large amounts of money into a company.

How to Find an Angel Investor

Finding angel investors is a fairly straightforward process.

Start by focusing your search on finding someone close geographically as many angel investors like to play an active role in the business they fund. “We prefer to invest in businesses that are close to home,” Polanco says. “The vast majority of angel investments take place within 50 miles of the angel investor’s home or office.”

Next, target industry associations and digital platforms to locate a good angel investor. You might start with these two angel organizations:

Angel Capital Association (ACA). The ACA is the largest expert advancement association for angels on a global basis, with more than 14,000 private backers and more than 250 angel gatherings and licensed stages. The ACA operates in the U.S., Canada, South America and the Middle East.

Angel Messenger Forum (AMF). New companies looking for equity financing of $100,000 to $1 million can use the AMF to make introductions to pre-screened private and corporate angel backers.

Small businesses seeking angel funding can also use social media to find good angel investment candidates. LinkedIn, in particular, can be a gateway to angel investors—just use the search key to find angels operating in your local area.