An angel investor is a wealthy individual who invests their money in a company or start-up in exchange for ownership positions in the company, typically in the form of equity or convertible debt. Often angel investors invest in the early stages of development of a company, and they tend to have clear exit strategies. Angel investors are frequently individuals with excess funds looking for a higher rate of return on those funds than provided by traditional investment opportunities. This means that angel investments, with their inherent risks, typically represent only 10 percent of an angel investor's portfolio.
Angel investors often provide more favorable terms compared to other lenders, especially as they tend to invest in the entrepreneur starting the business, not the viability of the business. These investors are focused on helping startups take their first steps, rather than the possible profit, although the profit of a successful investment is still a motivation for angel investors. In some cases, angel investors invest through crowdfunding platforms or build angel investor networks to pool capital together.
As angel investors tend to invest from their own money, rather than invest money from other investors, they typically invest $25,000 to $100,000 in a company, but can go higher depending on the individual. Often, the funds come from a limited liability company, business trust, or investment fund. In the United States, the Securities Exchange Commission (SEC) requires an angel investor must have a minimum net worth of $1 million and an annual income of $200,000. The leading sectors in terms of angel investments are technology, healthcare, software, biotechnology, and energy industries.
Typical sources of angel investors
This is a form of online investing that involves raising funds from large groups of individuals investing amounts as small as $100, and essentially forming an online investment group.
Family and friends
One of the more common sources of funding for business startups interested in finding start-up money, and for some this is the only option for early funding. Given the rate of failure of many businesses, it is risky in terms of the possible impact on relationships. It can be important to be upfront with family and friends about the risk of failure.
Increasingly, interested angel investors operate as part of a group or syndicate of angel investors, which raises their potential investment level accordingly. Investors contribute funds to the syndicate, and often a professional management team chooses the investments.
Another source is successful business people, doctors, lawyers, and others that have a high net worth and are willing to invest in return for equity. Often these deals are negotiated by word of mouth through business associates or associations.
Typically, as angel investors are investors, they look for a return on their investment; to improve their odds of receiving those funds back, with appreciation, they will evaluate a business based on a variety of criteria:
- The experience and track record of the founders
- The viability of the business plan
- An innovative or disruptive product or service
- The scalability of the business
- Existing revenue
- An exit strategy
The term "angel" originated in Broadway theater, where wealthy individuals would give money to a theatrical production. These individuals provided funds the productions paid back in full plus interest once they were generating revenue. The term "angel investor" was first used by William Wetzel, out of the University of Hampshire, during his study on how entrepreneurs gathered capital. The term was coined by Wetzel in 1978, and he used the term to describe investors who supported start-up businesses with seed capital.
For business owners, the advantage that financing from angel investors brings is that it tends to be less risky than debt financing. Unlike a loan, invested capital does not have to be returned in the event of business failure. Also unlike a loan, angel investors look to understand the lifecycle of businesses, and take a long-term view. Often angel investors are also looking for a personal opportunity, on top of an investment.
From the same perspective, the disadvantage of using angel investors is the loss of complete control, as the angel investor will have a say in how the business is run while also receiving a portion of revenue and profits when, or if, the business is sold. With debt financing, the lending institution does not control the operations and does not take share in the profits.
While there is a lot of crossover between angel investors and venture capitalists, mainly that both fund start-up companies in exchange for equity, there remain many differences. Perhaps the first main difference is the stage at which they fund a company, with angel investors typically investing very early in the lifecycle of a company. While venture capitalists generally invest at later stages in the company, if not at all stages.
Another difference is the source of funding between angel investors and venture capitalists. Angel investors tend to invest their own funds. And as part of this, they tend to invest in smaller amounts, ranging from as little as $10,000 to over $1 million. But this amount depends on the relative wealth of the individual angel investor, and has to comply with SEC regulations in regard to the funding. Venture capitalists, on the other hand, are professional investors who generally invest other people's money at their discretion. This allows the funding coming from these professional investors to generally be larger than $2 million, depending on the opportunity involved.
Another difference between angel investors and venture capitalists involves the level of involvement they take in the company. While angel investors can take an active role in a business, they are more than likely to keep a hands-off policy on company involvement. This can be especially in a scenario where the angel investors lack the knowledge a business may need to grow. Venture capitalists, on the other hand, are considered to be more involved, often taking or requiring a board seat, and involved operationally in a company in order to help that company grow and maximize the return on their investment.
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