What is an angel investor?
Angel investors are also known by several other names including private investors, angel investors, and seed investors.
They are high-net-worth individuals (HNWI) who are known for investing in entrepreneurs, startups, and small businesses. They usually receive a private equity stake in return for their investment.
Some angel investors are professionals who invest over and over again in different ventures, while others might just be family and friends of the entrepreneur.
Angel investments are usually made early in the life of a business venture. They can cover one-off setup costs or multiple instalments to take care of ongoing operating costs until the business is profitable.
How do angel investors work?
Angel investors are usually very wealthy individuals. They might have a substantial investment portfolio of which their investments are worth 10% or less.
The money they put into investments is usually disposable. While they hope for a return on their investment, many startup companies fail in their first years.
Because of this, angel investing is relatively high risk. Losses are not uncommon, and an experienced angel investor will take this into account across their portfolio.
Why choose an angel investor?
Angel investors are usually more interested in helping early-stage companies to succeed than venture capitalists (VCs), who are more focused on making a profit.
Business owners can also benefit from the experience and expertise of an angel investor. It's not uncommon to choose an angel investor with specific expertise in a particular sector or target market.
In return, an angel investor will often consider the skills and experience of the entrepreneur, as well as their business plan.
Are angel investors accredited investors?
Many angel investors have accredited investor status. The SEC defines this as:
- Net worth of over $1 million in assets (not including personal residences) OR
- Income of over $200,000 for the past two years OR
- Combined income of over $300,000 for married couples
There are good reasons why accredited investors might be more likely to be angel investors and vice versa. One such reason is their greater disposable income to put into risky ventures.
However, accredited status is not mandatory to be an angel investor. Equally, accredited investors can invest in other ways too. There is no direct link between the two in either case.
Where the money comes from
The source of funding is one area where angel investors are quite different from most others. They are usually looking to place their own money, which is generally a single and potentially large investment.
In comparison, other sources, like venture capitalists, may represent a large number of smaller investors who have pooled their resources. This is one more reason why venture capitalists often look to make a profit quickly, as their investors may expect a fast rate of return. A company with investment from a venture capital firm is usually known as a portfolio company.
Angel investors often operate through a company or other vehicle, ranging from limited liability companies (LLCs) to investment funds and trusts. Even if an individual is putting up the money, it might look as though it is coming from an institution.
Ending an angel investment
Angel investors can be very helpful, but they are also savvy and experienced. They might ask for a defined exit strategy so that if anything goes wrong, they don't lose their entire investment.
A carefully managed angel investment can return around 20-30% for the investor. But this shouldn't be seen as a 20-30% loss for the entrepreneur.
Angel investment is not a zero-sum game. Together, the entrepreneur and the investor can build much higher value in the business, so that both come out with substantial gains.
Because of this, angel investment might be one of the few sources of funding to help turn an idea into a profitable reality.
Over the course of several decades, this has led to angel investing becoming a popular source of startup finance.
This is particularly true where a relationship becomes long-term, as an angel investor might choose to support the entrepreneur through subsequent ventures that also lead to success.