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An angel investor is usually a high-net-worth individual who invests their own money in a startup, frequently in exchange for an ownership stake in the business. Angels typically invest their money in the early stages of a business's formation.
In 2020, angel investments in the U.S. totaled $25.3 billion, up 6% from the previous year, according to a report from the University of New Hampshire's Center for Venture Research. Some 64,480 businesses received angel funding in 2020, with the number of active angel investors pegged at 334,680.
Who Are Angel Investors?
Angel investors tend to be wealthy people who are trying to diversify their investment portfolios or who simply enjoy investing as a hobby. An individual angel investor typically invests $5,000 to $100,000 in one round of funding for a startup. This investor may invest on their own or may join forces with other angel investors to make a pooled investment.
Angel investors are also frequently accredited investors. An accredited investor is someone who has earned income exceeding $200,000 during each of the previous two years (or a combined income of $300,000 for a married couple) or someone with a net worth of at least $1 million.
In exchange for their investment, an angel investor typically receives an ownership stake in the business or something called convertible debt. In a convertible debt deal, an investor lends money to a business with the expectation that this short-term loan will be repaid in the form of equity in the company.
How Do Angel Investors Differ From Venture Capitalists?
While angel investors and venture capitalists both invest money in businesses, they differ in several ways:
- Angels normally invest their own money in a business, whereas venture capitalists generally invest money collected from sources such as insurance companies and retirement funds.
- Angels typically put money into startups and other early-stage businesses, while venture capitalists often put money into later-stage companies.
- Angels normally invest no more than $100,000 in one funding round for a company, whereas venture capitalists usually put at least $2 million into a single funding round.
How Angel Investing Works
Angel investing is a fairly straightforward process. Let's say you're the founder of a software startup, and you're seeking $50,000 from an angel investor as part of a $250,000 goal. Here are the steps involved in raising money from an angel investor.
- Vet the investor. Once you've found a willing angel investor, do your homework. This includes researching the investor's background so you can be sure they possess a good reputation as well as solid experience in working with startups.
- Hand over your business plan. The prospective angel investor will want to check out your business plan to make sure the company meets their investment expectations. They will review the business's product or service offerings, financial statements and competitive landscape, among other important details.
- Negotiate the deal. You and the angel investor then will agree to terms and conditions that will be spelled out in what's known as a term sheet. For the above software startup scenario, the term sheet might indicate that the angel investor will gain a 10% stake in the company for their $50,000 investment.
- Secure the money. After you've signed the term sheet, it's time for the investor to chip in the agreed amount of money.
How Do Angel Investors Benefit From Their Investment?
While angel investing can be risky for an investor, there are a lot of ways they can benefit. Here are some of the reasons angel investors like this kind of investing:
- They might wind up backing a startup that grows into a successful, valuable company. Examples of companies that once received angel investments include Amazon, Facebook, Google, PayPal and Starbucks.
- They can use their investment to diversify their investment portfolio.
- They can contribute their expertise, or gain new expertise about a certain industry.
- They get the opportunity to mentor and coach entrepreneurs.
- They may have a shot at entering or reentering the leadership ranks of a company.
Pros and Cons of Angel Investing
Just as with any type of investment, there are pros and cons involved for businesses who accept money from an angel investor.
- Your business gets more money to grow.
- You're not relying on riskier sources of money, such as bank loans.
- You benefit from the investor's business experience.
- You gain access to the investor's business network.
- The investor may be relatively patient when it comes to the timeline for reaping investment returns because your company is in its early stages.
- The investor might be less hands-on than other investors, such as venture capitalists.
- The investor may continue to contribute to your company's long-term survival by making follow-up investments.
- You may lose more equity in your business than you'd like to give up.
- You could end up with an investor who's a micro-manager.
- You might need to hustle to find several angel investors in order to raise your targeted amount of money.
- The investor may place greater expectations on you because they own a chunk of your business.
- You may find it takes a lot of time to find an angel investor who's a good fit.
How to Find an Angel Investor
Here are seven tips to get you started with your search for an angel investor:
- Visit websites of organizations such as the Angel Capital Association, Angel Investment Network and Angel Resource Institute.
- Contact your local chamber of commerce. They may be able to connect you with angel entrepreneurs in your area.
- Attend networking events for entrepreneurs.
- Ask professionals you do business with. Perhaps your banker, accountant or lawyer is familiar with an angel investor who might be interested in your business.
- Check out the entrepreneurship program at a local university. Professors and others there might be able to steer you toward potential investors.
- Join a trade organization. If, for instance, you're running a software company, then consider becoming a member of a trade organization for the tech industry. Other members may be able to refer you to prospective investors.
- Reach out to local entrepreneurs who've achieved success in your industry.
The Bottom Line
For a young business, access to an angel investor's cash might make the difference between being buried in the startup graveyard and ascending to Amazon or Google status. If you go down the angel investment path, be sure to do your homework and to pick an investor who's right for you and your business.