Angel investing is the form of investment done by friends and family or high net worth individuals. They invest their capital in private companies that are in difficult early stages and get an ownership stake in the business or convertible debt in exchange.
Angel investors are also known as informal investors, seed investors or business angels. They bridge the gap between raising money through smaller sources of financing and venture capitalists. Angel investors invest their own personal funds in early-stage companies whereas venture capital funding comes from a pooled source of funds. Angel capital is invested through vehicles like an investment fund, a trust or a limited liability company.
And thanks to equity crowdfunding, now we can all be angel investors…
How Can You Start Angel Investing?
It used to be that in order to be an angel investor, one needed to meet the Securities Exchange Commission’s standards for becoming an accredited investor. The minimum requirements are a minimum net worth of $1 million and an annual income of $250K for the past 3 years. Luckily, this is no longer the case.
An angel investor has to be good at making decisions on the basis of due diligence of start-ups before investment. It is an essential step because very little information about the management and business of a company which is in its early stages is typically available on the internet.
Equity crowdfunding portals like Wefunder and StartEngine have helped to improve this for the equity crowdfunding market, but we think we need to go a step further, which is where KingsCrowd comes into play. We take the time to deep dive into businesses raising capital from the crowd of angels and provide in-depth insights on these organizations.
What Does an Angel Investor Look For?
When it comes to analyzing a startup you are considering investing in it is important to consider some of the following criteria.
Large Market Size: Solving hard problems in big markets (e.g., healthcare, financial services) present attractive problems to solve because of the immense market opportunity to exist. Winning in a multi-billion or even trillion dollar market will lead to much better outcomes than investing in a business that owns a niche market that is maybe $10 or $20M in size.
Founders: It goes without saying, but founders who have been around the block one or more times typically have identified the pitfalls of starting up and learned from them. So much of investing in early stage companies is believing in the founders ability to execute on the vision. You want to invest in great people above all else. Make sure you know who you are backing.
Fair Terms: When considering an early stage investment you need to remember you are taking on sizeable risk and thus need to be rewarded with terms that enable enough upside potential to justify the high risk.
Market Competitors: You want to understand the competitive set for two reasons. One, we always want to invest in products or services that are 10X better than the incumbents (e.g., Uber versus Taxis). That’s how startups win over large portions of markets. The other reason to understand the competitors is because they could present potential strategic acquisition opportunities down the road.
Traction: If the company has already got the business running beyond the product stage, it is important to consider what type of traction they have, if the potential financials look promising and if the team seems to have the ability to actually execute on the capital they have.
Risk and Returns of Angel Investing
It is a well-known fact that the higher the risk, the greater is the return. Angel investing is quite risky in nature because of the probability of failure of the company the angel capital was invested in.
As per the U.S. Census Bureau, approximately 50% of start-ups fail within a few years of their launch. Since angel investing is highly risky, the rewards should also be in the same proportion.
Angel investors are seeking multiple times the return on their investment (typically 10X+) within five to seven years. However, return periods can vary significantly and have in recent years grown in length. Great Angels also look to assist management with their expertise and networks to help their own investment thrive.
Experienced angel investors earn a return of around 31% – 40% on their investment, but once again this can vary widely, and due diligence is key to ensuring you end up on the right side of the deal.
Advantages of Angel Investing for Business Owners
Let us discuss some of the advantages of finding angel investors for one’s business:
1) The range of Funding Available – The companies that are beyond the startup phase but still in the struggling early years are best suited to angel investing. Angel investors can provide funds ranging from a few hundred dollars to $2 million.
2) Guidance – Besides cash, angel investors also help entrepreneurs with industry-specific knowledge and their strong network and contacts. Angel investors are generally more experienced and help the business owners in various decision-making processes.
3) Collateral Not Needed – In order to raise funds through angel investors, one does not have to keep his personal assets on the line.
4) Repayment Not Required in Initial Stages – In comparison to other forms of credit financing, angel investment is a cheaper option. Other than the part of profits apportioned to the investor, the business owner does not have to worry about regular payments of capital or interest.
Disadvantages of Angel Investing for Business Owners
Every coin has two sides. There are some disadvantages of Angel Investing as well which are discussed below:
1) Difficulty in Finding Angel Investors – In comparison to venture capitalists, it is much harder to find angel investors for any business because of the huge demand and supply gap. However, equity crowdfunding markets are helping to solve for this.
2) Control Loss in One’s Own Business – In return for the capital invested by angel investors, they could demand a large stake of the company which could give them a controlling stake in the business. The larger the amount they invest in a company, the larger is their ownership stake. Generally, angel investors become non-executive board members of the businesses in which they have invested. The business owner may not be able to enjoy complete autonomy relating to his own business.
Angel investing is becoming increasingly important to the global innovation economy especially with the rise of equity crowdfunding. Whether to be an angel investor or not requires not only deploying capital but also introspection.
If one is okay in investing funds and time in a lot of startups and watching many of them fail, then, it can be considered. Similarly, in order to get angel investment for one’s business, one should be well prepared and do the homework required before approaching angels.
Also, one should be prepared to share control of his/her business with the angel and involve him in the decision-making process of the business. Being an angel has never been easier and more accessible. Subscribe to KingsCrowd to make due diligence easy and get access to the best startup research and ratings so you can invest like a pro Angel.