What is an Angel Investor?
An angel investor is a type of individual investor who provides funding to up-and-coming startups in return for equity in the company.
Usually high-net-worth individuals, angel investors seek early-stage companies with promising futures, in the hopes that their financial gamble will pay off. They're also referred to as seed investors, angel funders, and private investors.
How does angel investing work?
Simply put, an angel investor agrees to provide a startup with funding in exchange for a stake in the company. This makes angel investing a type of equity financing.
The average angel investment is $330,000, with angel investors typically taking between a 20% to 50% stake in a company. Neither of these amounts is set in stone — it is up to each angel investor and the company they are investing in to negotiate the terms of their agreement.
Angel investors usually expect a generous return on their investment. Generally speaking, they expect to get their money back within 5 to 7 years, with an annualized internal rate of return (IRR) of 20% to 40%.
Just like any other form of investment, angel investments come with a number of advantages and disadvantages for startups. The following are some key benefits associated with this form of investment:
- Startups that receive angel funding are more likely to survive, have an exit, and experience employee growth.
- The funding they provide isn’t in the form of a loan, so startups don’t need to make monthly or yearly loan repayments to them.
- A startup may be able to leverage the angel investor’s business knowledge and skills.
- Angel investors may be able to introduce the startup to their network, as well as lucrative opportunities they wouldn't otherwise encounter.
- Angel investors don’t usually need to be repaid if the business fails.
- Angel investors typically have a larger risk appetite to fund up-and-coming businesses than banks do with giving loans to them.
- Angel investors are active in a range of industries, so a business may be able to find someone who specializes in and understands their particular industry.
Startups considering using an angel investor should also keep their potential downsides in mind. They include:
- Angel investors are paid in equity, so startups need to give them a stake in the company.
- Given the risks involved in investing in fledgling businesses, angel investors’ expectations tend to be quite high, and in turn, can be difficult to meet.
- Angel investors often want a say in the startup’s direction, which may cause problems if the startup is seeking a more hands-off approach.
- There is relatively minimal paperwork involved (at least compared to some other forms of investment or loans).
- It can be challenging to find a suitable angel investor in the first place, so obtaining funding can be a slow process.
- The amount and quality of support an angel investor provides a startup in terms of sharing their resources and helping solve problems may vary from angel investor to angel investor.
- Conflict can arise if the angel investor’s role in the company is ill-defined, or if they have different ideas to the startup about how it should be run.
What is the difference between an angel investor and venture capitalist?
While both types of investors use their capital to fund startups, there are several notable differences between angel investors and venture capitalists.
One of the most significant differences is where each type of investor sources their funding from. Angel investors use their own money, while venture capitalists typically use money from large corporations and investment companies.
The amount of funding angel investors and venture capitals provide is also starkly different. According to the SBA, the average angel investment is $330,000, while the average venture capital deal is around $11.7M.
The stage at which each type of investor funds a company is another point of distinction. Angel investors invest in companies in their early-stages, while venture capitalists usually invest in already established companies.
What’s more, angel investors are individuals working on their own behalf (although they may be part of an angel investment group), while venture capitalists are employees of venture capital firms.
Angel investors are sometimes compared to silent partners as well. Like venture capitalists, silent partners have several similarities and differences to angel investors that are also worth keeping in mind.
Who can become an angel investor?
As angel investors are typically financially savvy, high-net-worth individuals, they tend to come from well-paid professions in the business world. For example, company executives, financial advisors, and lawyers.
While angel investors don’t need to be previously acquainted with the startup, they are often close contacts of the startup’s founders. Friends and family members are a key source of angel funding for many startups.
In the past, only accredited investors were able to become angel investors. An accredited investor is someone who has been granted permission to participate in certain security offerings that aren’t available to the general public.
According to the SEC, an individual may become an accredited investor if they:
- Earned income that exceeded $200,000 (or $300,000 together with a spouse or spousal equivalent) in each of the prior two years, and reasonably expect the same for the current year, or
- Have a net worth over $1M, either alone or together with a spouse or spousal equivalent (excluding the value of the person’s primary residence), or
- Hold in good standing a Series 7, 65, or 82 license.
This helps to explain why angel investing is usually the domain of high-net-worth individuals.
That said, the passing of Title III of the JOBS Act (also known as the Crowdfund Act) made it possible for startups to receive funding from non-accredited investors. By opening up angel investing to non-accredited investors, Title III of the JOBS Act made angel investing much more accessible to individuals without a high net worth.
How do startups find an angel investor?
Startups have a variety of options at their disposal to find an angel investor .
There are numerous organizations and associations dedicated to angel investing that they can enquire with. For example, AngelList and the Angel Capital Association’s Member Directory. Startups can also turn to social media networks, such as LinkedIn, to find potential angel investors.
Startup leaders can also reach out to relevant contacts within their personal and professional networks. Another method is to simply search online for lists of angel investors to contact.
An angel investor is a unique type of investor who focuses on funding early-stage companies with bright futures. Anyone considering becoming one should ensure they exercise due diligence before investing in a startup. Likewise, startups considering getting financial support from one or more angel investors should weigh up both the pros and cons before doing so.