What Is Angel Investing?
Angel investing is a type of investing that helps startups, new businesses, and small firms receive the funding they need in exchange for shares or equity in the company. The individuals who participate in this type of investing are called angel investors.
If you're considering diversifying your portfolio and potentially increasing gains, then this page will help you understand the benefits of angel investing and how angel investing can help you reach your goals.
We'll discuss what angel investing is, who angel investors are, and compare angel investing vs. venture capital. Understanding angel investing and its benefits is the first step to seeing if it's right for you.
What Is an Angel Investor?
Angel investors - sometimes known as angel funders, private investors, or seed investors - are high net-worth individuals who provide financial backing to entrepreneurs, small businesses, or startups.
To become an angel investor, you must first become an accredited investor through the U.S. Securities and Exchange Commission (SEC) and meet several guidelines including having individual or joint net worth over $1 million.
Individuals can also be micro investors. Micro investors invest in smaller amounts with some platforms allowing investors to start with just a few dollars. In certain cases, business owners secure financing from family and friends. These family and friends may take on the label of "angel investor" even if they are not accredited investors themselves.
While each of these investors could be categorized as angel investors, the primary focus of this chapter is on those seeking significant investments with accreditation.
How Do Angel Investors Make Money?
Angel investing is considered a high-risk form of investing. Because of the risk, angel investors typically only carry 11% or less of this type of investment in their portfolio. With this risk comes the possibility of reward. The Kauffman Foundation found that the average estimated return an angel investor can expect is 2.5 times their initial investment.
Angel investors receive equity in the companies they invest in, with equity percentages ranging from 10% to 40%. If a business is profitable, angel investors get paid in two main ways:
- When a startup performs well and is sold or acquired by another entity, angel investors receive a share of the profits.
- When a company decides to offer shares on the public market, angel investors receive money as part of the initial public offering (IPO). They might also receive an option to cash out their shares for a profit.
A well-known angel investor is Ron Conway. As Founder of Angel Investors LP, he gained his angel investing wings by being an early investor in companies like Google and PayPal.
Ron Conway frequently invests early in a number of businesses, rather than making a single large investment in one business. This strategy enables him to diversify his investments and have a stake in many successful companies.
Not all angel investors use Ron Conway's investing strategy. Angel investor Neil Patel looks at the size of a startup's potential market and only invests in companies solving a problem many people or businesses have.
Pros and Cons of Angel Investing
Now that you understand the basics of angel investing, we'll take you through the benefits of angel investing and a few drawbacks. This background information may help you determine if this type of investing is right for you.
Pro: Rewarding for Investors
Many investors specifically choose angel investing because they find the process rewarding. Angel investors are frequently former business owners or entrepreneurs who want to mentor new small business owners and give back to the business community. Investing in small businesses and startups becomes a win-win situation for both the business owners and for investors because it offers investors a diverse portfolio and supports small businesses in the process.
Pro: Potential for High Returns
Although angel investing involves some risk, if a business venture is successful, angel investors may yield high returns. To maximize the chances of yielding a good return, angel investors often invest in multiple businesses.
Pro: May Offer Decision-Making Power
Since angel investors receive a share of the company's equity, they may also receive some say over how the company is managed. If you enjoy troubleshooting financial hurdles and making operating decisions, you'll likely enjoy being an angel advisor.
Con: It Requires Patience
It can take time to find a startup or business plan you feel confident investing in. Likewise, even if you find a company you're willing to invest in, it might take time to see positive returns.
Con: Potentially High-Risk
While angel investing may lead to high returns, it's risky and you can lose your investment. Doing your due diligence by researching and being discerning when choosing where to invest can help mitigate risk.
Angel Investing vs. Venture Capital
Angel investing is often confused with venture capital. While both types of investing can be used to fund startups or expand businesses, how these businesses are funded and the details of the funding are very different.
Here are a few key differences that separate angel investing from venture capital.
Funding Source
The main difference between angel investors and venture capitalists is the source of their funding. Angel investors finance startups by using their own funds. Venture capitalists, on the other hand, provide financing from pooled money that has been placed in an investment fund.
Types of Businesses They Fund
Angel investors typically focus on new businesses and smaller businesses, while venture capitalists are more interested in proven, well-established companies, like enterprise organizations.
Amount Invested
In addition, the amount invested by both types of investors is very different. Angel investors typically invest anywhere from $25,000 to $100,000 in new businesses. Venture capitalists often invest from $1 million and up.
Company Control
Angel investors typically invest in exchange for equity in a small business. Venture capitalists not only receive equity, but also often require a seat on the board of directors or shareholders for the companies they invest in. This means venture capitalists have more say in what happens in the businesses they finance.
Should I Become an Angel Investor?
Understanding what angel investing is and how it works are the first steps to becoming an angel investor. If you enjoy helping and mentoring entrepreneurs and are open to higher-risk investments, then you might be a perfect fit for angel investing.
To learn more about angel investing, check out the rest of our guide where we dive deeper into angel investment opportunities, the steps to becoming an angel investor, and more.
