Angel investors are small-scale venture capitalists. They are generally high-net-worth individuals who provide seed capital to startup companies. Many angels were once entrepreneurs themselves who have successfully built and run their own businesses. Startups often rely heavily on initial investors for their expertise, advice, and business contacts. Most startups seek angel money first—usually somewhere between $100,000 and $1 million—to get off the ground. Once startups have proven their business model to an extent and achieved a few milestones, they then seek early-stage funding from traditional venture capitalists—often $1 million to $5 million and up.
Angel investing is long term, as the investment may be illiquid for several years. Angel investors usually only stand to realize a profit once the company goes public through an IPO or is acquired by another company.
Angels often form “bands” by organizing into groups with other angel investors. Professional venture capitalists are more inclined to invest with a band than with an individual angel in later investment rounds. Note that band members are sometimes professional venture capitalists themselves, but invest as angels for early access to premier deals.
Angels are increasingly important to seed-stage companies due to traditional venture capitalists’ reluctance to take stakes in these start-ups, preferring to invest in larger, later-stage companies.
Angel investing is a proactive way for individuals to invest in private equity—an important asset class into which investors can diversify amidst today’s markets. Instead of pooling their money in an oversized venture capital fund, angel investors are taking a chance on these seed companies and can reap outsize benefits when successful.
The greater the potential reward, however, the greater the potential risk—and angel investing is certainly no exception. First and foremost, you’re putting money behind an unknown that lacks a proven business model. And, that being the case, there’s actually a very good chance you won’t see any return at all. There are of course a few ways to try and boost your odds of success by doing a great deal of research into whether the company’s product or service is differentiated in the marketplace, whether the team has experience in leveraging other concepts—and you could also try and diversify risk by spreading out your investment over a few companies.
How do you become an angel investor?
Many relationships result from networking with lawyers, accountants, and financial service providers who work with early stage companies and other angel investors. The most basic deals are struck up among a personal contact of some sort (e.g., friends, family, and/or associates), making these deals exclusive as well as elusive. Angel investing also requires a high level of involvement and expertise in the industry or fieldwork. If you have the money and the know-how, those seeking funds will often find you.
Although it provides investors with diversification and low correlation, angel investing carries high risk. Angels should be risk-tolerant, unconstrained by liquidity concerns and have extended investment time horizons. When angels come to the aid of a startup, the company often has little or no market value, it is unproven in the marketplace, and it might not even be producing revenue. The key to success is measured when the angel exits the investment and their returns are realized. The key to success is measured when the angel exits the investment, and the returns are realized. But until that moment happens, it can be one bumpy ride.
This article is for informational purposes only and is not intended as an offer or solicitation for the sale of any financial product or service or as a determination that any investment strategy is suitable for a specific investor. Investors should seek financial advice regarding the suitability of any investment strategy based on their objectives, financial situations, and particular needs. This article is not designed or intended to provide financial, tax, legal, accounting, investment, or other professional advice since such advice always requires consideration of individual circumstances. If professional advice is needed, the services of a professional advisor should be sought.
All investments involve risks, including possible loss of principal. There is no assurance that any investment strategy will be successful. Diversification does not ensure a profit or guarantee against a loss.