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What Is Angel Investing?

UTC by Beatrice Mastropietro · 10 min read
What Is Angel Investing?
Photo: Depositphotos

Angel investors are typically people with business experience who may have retired from other careers and want to help new entrepreneurs succeed. In this guide, we will discuss why angel investing is such an attractive idea as well as what you need to know if you plan on becoming an angel investor yourself.

Angel investing is a way to put your money into startups and growing companies. Angel investors are often affluent individuals who can use their own money to invest in unproven or new enterprises looking for funding. They commit capital on the belief that they will receive some return on their investments, such as an eventual share of profits, support from entrepreneurs, and the satisfaction of supporting a good cause.

Angel investing is different than the stock market. It is not as easy to lose your money or be scammed on angel investing as it is with stocks. You can participate in some of the nation’s most dynamic companies, even before they hit it big and become public corporations. Some investors enjoy angel investing for this reason alone. They think that by getting in early, they can make a lot of money when these small businesses grow into multi-million dollar companies. Others may feel that social good is associated with helping entrepreneurs get their ideas off the ground and providing jobs for people who need them. Still, others simply enjoy being part of a community where lots of money changes hands quickly, and new relationships are forged. No matter why you get involved, angel investing is a great way to make your money work for you.

How Angel Investing Works?

Angels invest their capital in return for an equity stake in the business, which means they become part owners and have a say in how the company is run. These venture capitalists only put money into companies that they believe will succeed and can offer them some sort of leverage or benefit and financial gain down the road. It’s not uncommon for angels to consult with entrepreneurs on issues like recruitment and overall business strategy.

Angel investing is similar to venture capital investing, but there are some key differences. First of all, angels usually invest their funds or pool together smaller amounts of money from several sources to make more significant investments than venture capitalists do. Angels tend to be more patient over a longer period as well. In contrast, a typical venture capitalist may look for an initial public offering (IPO) rather than taking a company’s business plans through to acquisition.

Another thing that makes angel investors unique is that most of them don’t follow a set of specific rules on how much to put into a specific company or when to invest. Meanwhile, venture capitalists often rely on a fund that has been set up specifically for the type of investment they are seeking, which is far more structured than angel investing.

Another critical characteristic of angel investors is their approach to exits. Venture capitalists usually look for an IPO or a buyout as they have time to sell their shares and realize their returns on investment (ROI). On the other hand, angels often hold out until there is a takeover and then cash in just like any shareholder would.

Although it is not always possible, angels looking for suitable investments tend to focus on local ventures that provide goods and services within a small geographic area. That way, they can attend regular shareholder meetings and stay familiar with what is going on in the business world in a particular industry.

Angels are also more likely to support risky ideas that have yet to prove themselves successful in the marketplace. As long as you are confident your idea will revolutionize your industry or create an entirely new one, you are more likely to find success with an angel investor than a venture capitalist.

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 net worth.

Angels may also be more patient with entrepreneurs and open to providing smaller dollar amounts for a more extended period than venture capitalists. 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.

Sources of Angel Investing

Sources of angel investing are numerous. Here are some of them:

  • Angel groups, or networks of angel investors who meet regularly and often invest in each other’s deals. For example, as of the end of 2021, California has 1,400 angel groups, New York has over 200 angel groups. It is followed by Colorado (120), Texas (110), and Massachusetts (100).
  • Angel organizations – membership-based associations for individual angel investors to network and share deal flow information. Membership can range from 20-30 to more than 500 members. While there are no standardized criteria for joining an association, you must be vetted by someone already part of the organization before joining. Fees vary depending on the organization.
  • Angel brokers, which are intermediaries between angel investors and startups. These firms help portfolio companies find angels for capital or join syndicates with other angels to increase deal flow or exit potential. A broker usually charges an annual membership fee plus a transaction fee upon closing deals. Each investor decides how much he/she is willing to commit and how long.

How to Become an Angel Investor

To be an angel investor, you should first become familiar with business concepts. Angel investors may not all be experts in the industry, but they should understand at least basic business concepts like markets and revenue models. You should also understand how to value startup companies, including what multiples of earnings are reasonable for startups versus mature companies. Finally, learn about management team compensation structures, preferred stock terms, and IPO processes.

Further, evaluate the investment opportunity. One of the biggest challenges for angel investors is finding suitable investment opportunities to fund. You must first research attractive investments in early-stage companies by looking at their business plan, management team, financial projections, and other factors. Next, you must make an offer to invest. You can’t always dictate the terms, but you should be ready to negotiate.

Next, find the money for investing. It is also important for angel investors to build their net worth before seeking opportunities, and it may be easier than you think. If possible, save enough capital for several investments or use existing investments to finance angel investing.

Besides, seek professional help. If you don’t have specific knowledge or expertise in an industry, it is a good idea to consult your CPA and attorney before making any investments.

Finally, get started with small investments. Once you know what types of investments you would like to make, get yourself connected with other angel investors and work on making a few small investments to gain experience. Once you become more experienced, it is easier to identify good opportunities that could lead to larger investments.

Why Consider Angel Investing

Angel investors are high-net-worth individuals. They usually include successful entrepreneurs and businesspeople, or venture capital (VC) firms who provide seed funding to start-ups. The money is often used to support a new product or service launch. Angel investors generally have a strong understanding of the industry they invest in. For example, they rely on Internet technology, healthcare, education, or clean energy. Besides, they are willing to take risks on young start-up companies that have high growth potential but are not yet able to attract the attention of more mainstream investors such as VCs or banks.

Preferred industries for angel investment include software, biotechnology, medical devices, business services, consumer goods, and hardware. However, there is some overlap between these categories, therefore it is important to consider which sectors you want your investment money to focus on. Notably, there are fewer female angels than male ones, partly explaining why there are bigger funding gaps for women entrepreneurs.

Investors look for strong management teams with a clear structure, plan, and vision. They want to see evidence of a good track record (perhaps they have worked together before) and a thorough understanding of the market opportunity. Funding usually goes towards developing a prototype or business plan. Still, angel investors are more interested in an exciting concept than a fully formed idea, so it can be helpful to give them as much information as you can about potential growth opportunities. Sometimes people who consider themselves ‘angel investors’ may also be high-net-worth individuals looking for investment opportunities closer to home rather than abroad. In this case, they will expect you to travel up to twice per month at your own expense for board meetings.

Regulation of Angel Investments

Regulation of angel investing can be beneficial for many, but it may on the other hand limit the ability to raise funds worldwide. There are certain rules and regulations that must be met when a business or individual is trying to raise money through angel investments. Angel investment is defined as the process of putting money into a business to help it become successful. Regulation of angel investment can impact many different things, such as tax laws and any minimum capital that must be raised before an initial public offering can happen. The current US economic conditions have created a need for regulation of angel investing, but it can also hinder those trying to raise funds.

Venture capitalists and angel investors are often grouping since they invest in companies with high risk and high return potential. They make risky investments hoping that they will gain big returns, which is why a large amount of regulation is needed. The US Securities and Exchange Commission (SEC) regulates both venture capitalists and angel investors, but each group has different rules that they must follow.

Advantages and Disadvantages of Angel Investing

The advantages of angel investments are numerous. The major ones include greater returns and greater diversity. Time and time again, we have seen that angel investors almost always make higher returns than the ones who invest in traditional investments like mutual funds or bank fixed deposits. In addition, angel investors are not dependent on any fixed asset for returns, while mutual funds depend on stock markets, and fixed deposits depend on banks.

However, there are some risks around angel investing. For one, you run the risk of your money being lost forever if the business fails, which is why having an exit strategy in place is important. You also take on more risk when you invest in small businesses instead of major corporations because there is always a greater chance that these companies will fail. That said, some angels enjoy participating in small businesses because there is often significantly less bureaucracy involved than at larger organizations where many hands must approve each action taken.

Conclusion

The most important thing to understand about angel investing is that you might lose all of your money. Remember, this is generally not an investment strategy for those with little disposable income. Angel investors are looking for companies that can offer big returns on their investments. A good idea does not automatically equate to a lucrative business opportunity, and angel investors know better than most people how important it is to be careful when they are putting their hard-earned cash at risk.

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FAQ

What is angel investing?

Angel investing is a way to put your money into startups and growing companies. Angel investors are often affluent individuals who can use their own money to invest in unproven or new enterprises looking for funding. They commit capital on the belief that they will receive some return on their investments, such as an eventual share of profits, support from entrepreneurs, and the satisfaction of supporting a good cause.

Who are angel investors?

Angel investors are wealthy individuals who are willing to invest in early-stage companies.

What are the sources of angel investing?

The most common sources of angel investments are wealthy individuals, crowdfunding, and angel syndicates.

How is angel investing regulated?

There are no legal requirements for angel investors to be registered with the SEC. However, there are rules for governing investments made by individuals or corporations in startup businesses. 

What are the benefits of angel investing?

The advantages of angel investments are numerous. The major ones include greater returns and greater diversity. Time and time again, we have seen that angel investors almost always make higher returns than the ones who invest in traditional investments like mutual funds or bank fixed deposits. In addition, angel investors are not dependent on any fixed asset for returns, while mutual funds depend on stock markets, and fixed deposits depend on banks. 

What are the risks of angel investing?

With angel investing, you run the risk of your money being lost forever if the business fails, which is why having an exit strategy in place is important. You also take on more risk when you invest in small businesses instead of major corporations because there is always a greater chance that these companies will fail. That said, some angels enjoy participating in small businesses because there is often significantly less bureaucracy involved than at larger organizations where many hands must approve each action taken. 

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