Angel Investors

What are Angel Investors?

Definition: Angel investors, also called private investors, are wealthy individuals who infuse a startup company or an entrepreneur with cash or capital in exchange for ownership or convertible debt because they believe in the company and think it will succeed. Angels are different than venture capitalist because they fund the endeavors personally and usually want to entrepreneur and business to succeed for more reasons than just profits.

What Does Angel Investors Mean?

Angel investors are individuals who seek to invest at the early stages of startups. These types of investments are risky and usually do not represent more than 10% of the angel investor’s portfolio. Most angel investors have excess funds available and are looking for a higher rate of return than those provided by traditional investment opportunities.

Angel investors provide more favorable terms compared to other lenders, since they usually invest in the entrepreneur starting the business rather than the viability of the business.1 Angel investors are focused on helping startups take their first steps, rather than the possible profit they may get from the business. Essentially, angel investors are the opposite of venture capitalists.

Angel investors are also called informal investors, angel funders, private investors, seed investors or business angels. These are individuals, normally affluent, who inject capital for startups in exchange for ownership equity or convertible debt. Some angel investors invest through crowdfunding platforms online or build angel investor networks to pool capital together.

What Defines a Business Angel?

Angel investors are easily distinguishable from other types of investors, such as venture capitalists, through several factors:

  • They invest their own money into the project, less than would be invested by a venture capitalist
  • They make their own decisions concerning investments
  • They invest according to the viability of the project, with expectations of future gains
  • Their main objective is to receive a return on their investment
  • There are different types of business angels and their relationship to your business.
  • They can be affiliated; which can include suppliers, customers, or even competitors.
  • They can also be nonaffiliated; which means they are individuals without a previous connection with your company.

Business angels can be an excellent way for a new company to gain ground quickly and step into a new stage of growth. By providing capital and guidance, the investment can have a substantial impact on the business.

Angel investors essentially provide a bridge between a fledgling business concept and a company that is developed enough to receive funds from a venture capitalist.

Advantages and Disadvantages of Angel Investors for Business Owners

The big advantage is that financing from angel investments is much less risky than debt financing. Unlike a loan, invested capital does not have to be paid back in the event of business failure. And, most angel investors understand business and take a long-term view. Also, an angel investor is often looking for a personal opportunity as well as an investment.

The primary disadvantage of using angel investors is the loss of complete control as a part-owner. Your angel investor will have a say in how the business is run and will also receive a portion of the profits when the business is sold. With debt financing, the lending institution has no control over the operations of your company and takes no share of the profits.

Typical Sources of Angel Investors

Angel investor is a somewhat general term, and you can actually find these types of investors in a few different forms. Angel investments normally come from:

  • Family and friends: This is by far the most common source of funding for business startups that are interested in finding business start-up money and is the only option for many. Given the high rate of failure with new businesses, it is also risky in terms of the possible impact on relationships if the business is not successful. It is important to be upfront about the risk of failure.
  • Wealthy individuals: Another good source is successful business people, doctors, lawyers, and others that have a high net worth and are willing to invest up to (typically) $500,000 in return for equity. Often this is done by word of mouth through business associates or associations such as the local Chamber of Commerce.
  • Groups: Angels are increasingly operating as part of an angel syndicate (a group of angel investors), which raises their potential investment level accordingly. Investors contribute funds to the syndicate and a professional syndicate management team chooses the investments.
  • Crowdfunding: A form of an online investing group, crowdfunding involves raising funding by having large groups of individuals invest amounts as small as $1,000.

Investment Profile

Angel investors who seed startups that fail during their early stages lose their investments completely. This is why professional angel investors look for opportunities for a defined exit strategy, acquisitions or initial public offerings (IPOs).

The effective internal rate of return for a successful portfolio for angel investors is approximately 22%. Though this may look good for investors and seem too expensive for entrepreneurs with early-stage businesses, cheaper sources of financing such as banks are not usually available for such business ventures. This makes angel investments perfect for entrepreneurs who are still financially struggling during the startup phase of their business.

Angel investing has grown over the past few decades as the lure of profitability has allowed it to become a primary source of funding for many startups. This, in turn, has fostered innovation which translates into economic growth.

Angel investments bear extremely high risks and are usually subject to dilution from future investment rounds. As such, they require a very high return on investment. Because a large percentage of angel investments are lost completely when early stage companies fail, professional angel investors seek investments that have the potential to return at least ten or more times their original investment within 5 years, through a defined exit strategy, such as plans for an initial public offering or an acquisition.

Current ‘best practices’ suggest that angels might do better setting their sights even higher, looking for companies that will have at least the potential to provide a 20x-30x return over a five- to seven-year holding period. After taking into account the need to cover failed investments and the multi-year holding time for even the successful ones, however, the actual effective internal rate of return for a typical successful portfolio of angel investments is, in reality, typically as ‘low’ as 20–30%.

While the investor’s need for high rates of return on any given investment can thus make angel financing an expensive source of funds, cheaper sources of capital, such as bank financing, are usually not available for most early-stage ventures.

Summary

Define Angel Investors: Angel investor means a person who contributes money to a company, usually a startup, in hopes that the company will grow and their original investment will increase dramatically.

  • An angel investor is usually a high net worth individual who funds startups at the early stages, often with their own money.
  • Angel investing is often the primary source of funding for many startups who find it more appealing than other, more predatory, forms of funding.
  • The support that angel investors provide startups fosters innovation which translates into economic growth.
  • These types of investments are risky and usually do not represent more than 10% of the angel investor’s portfolio.