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Angel investors are individuals who offer promising startup companies funding in exchange for a piece of the business, usually in the form of equity or royalties. While figures vary on an annual basis, as recently as 2017 angel investors put approximately $25 billion into 70,000 companies.
Angel investors may or may not be accredited investors, a classification given only to investors with very high incomes or net worths. With the passage of 2012’s Jumpstart Our Business Startups Act, the criteria for startup investors was expanded to include more everyday retail investors, including crowdfunding campaigns.
Getting to Know Angel Investors
Angel investors often come from the business world—but that’s not their only point of origin. Angel investors are commonly found in the following professions:
• Business professionals, like lawyers, doctors, accountants and financial advisors, among other professions.
• C-level company executives, who have risen through the ranks and know what it takes to run a successful business.
• Successful small business owners and entrepreneurs who have already launched successful companies and know how to recognize startups that have a bright and profitable future.
• Investors who make financing small businesses a professional pastime.
• Crowdfunding platforms that raise pools of money in groups, with each person investing a small amount in exchange for a small share of any eventual profits, if the company proves successful.
How Angel Investing Works
Angel investors prefer to get involved in the early stage of a company, at the “seed” or “angel” funding phase. That could mean the angel invests when the company exists only as an idea, or it could come when a business is already up and running.
Sometimes angel investors arrive on the scene after the initial round of funding, which normally comes from the founders themselves, friends and family of the founders or from bank financing. Typically, initial business funding isn’t substantial—it’s common for founders to roll out their product or service with $10,000 or so in initial funding.
Angel investors come in after the original funding is in place but typically before a company requires a more sizable investment from a venture capital company. Their investment is needed to grow a company at a critical (and usually early) stage of development, after the initial funding threatens to run out and before venture capital groups show interest in partnering with a promising business.
Here’s how the actual investment process rolls out:
• Angel investors connect with young, developing companies through word of mouth, through business and industry seminars or conventions, through referrals from professional investment organizations, from online business forums or via local events like chamber of commerce meetings.
• If there’s mutual interest, the angel investor will conduct due diligence on the young company by talking to the founders, reviewing business investment documents and gauging the industry the company is targeting.
• Once a verbal agreement between an angel is in place, a term sheet or contract is drawn up, with agreements on the investment terms, payouts or equity percentages, investor rights and protections, governance and control parameters and an eventual exit strategy for the angel investor.
• Once the contract is finalized an actual legal agreement is created and signed, the deal is officially closed and the investment funds are released for the company’s use.
While contribution amounts vary, funding levels can be as low as $5,000 and as high as $150,000. Some angel investors group together as a syndicate and can provide funding up to $1 million for select companies.
Angel investors don’t usually acquire more than a 25% stake in a company. Veteran angel funders know that the company founders need to hold the highest stake in their own companies as they then also have the highest incentive to make their companies successful.
Angel Investors vs Venture Capitalists
While angel investors and venture capitalists (VCs) both fund companies in exchange for a piece of the action, there are significant differences between the two entities.
Though both angel investors and VCs invest in startups, they typically put in money at different stages in the process.
“An angel investor is more likely to provide capital for an idea whereas the majority of VCs would like a proof of concept in hand,” says Courtney Lawless, a venture capitalist at Philadelphia-based MoxeHub.
Another difference is the source of funds: Angel investors are private investors that invest their own money. Venture capitalists are professional investors who generally invest other people’s money, rather than their own money—although that’s not to say they never put in their own dollars.
Other differences include:
• Smaller funding amounts. As opposed to venture capitalists, who generally write funding checks of $2 million or more, individual angel investors typically write much smaller checks. “Those checks are typically between $10,000 and $100,000,” says Dave Lavinsky, co-founder of Growthink, a business funding provider in Bend, Ore.
• Angel investors are more likely to keep a “hands off” policy on company involvement. Venture capitalists, on the other hand, almost always take a board seat and are involved operationally in a company.
Advantages and Disadvantages of Angel Investing
There are several reasons why emerging startup companies might partner with an angel investor.
Angel Investor Advantages
• No obligations. Because they haven’t applied for a new line of credit and most angel investing involves equity deals, business owners don’t have to pay the angel funder back if the company goes belly up.
• An angel investor is usually an entrepreneur, too. Angel investors often have an abundance of business knowledge and experience. “Especially valuable are financial backers who have established effective organizations on their own,” says Garett Polanco, an accredited angel investor who’s funded 29 companies.
• Less administrative work. Organizations that raise financing from angels are free from onerous investment filings with the U.S. Security and Exchange Commission (SEC) and state regulators that they might have to if they decided to hold, for example, an IPO to raise money.
• More cash down the line. When angels fund a company, they’re often in for the long haul. “They often make another cash injection later on,” says Polanco.
Angel Investor Disadvantages
• Less control. Companies who work with angel partners may need to give up some amount of equity in their business. While that’s normally a small amount, angel financial backers may decide they want a bigger role in business decisions.
• A hit in the pocketbook. Angel investors require compensation for their funding. “That typically comes in the form of equity, which could be more expensive than debt financing,” Lavinsky says.
• Potential for novice investors. A big con of taking on angel investing is winding up with an inexperienced angel investor who offers poor advice or who hounds business owners for status updates. That can especially be the case with new angel funders who steer large amounts of money into a company.
How to Find an Angel Investor
Finding angel investors is a fairly straightforward process.
Start by focusing your search on finding someone close geographically as many angel investors like to play an active role in the business they fund. “We prefer to invest in businesses that are close to home,” Polanco says. “The vast majority of angel investments take place within 50 miles of the angel investor’s home or office.”
Next, target industry associations and digital platforms to locate a good angel investor. You might start with these two angel organizations:
Angel Capital Association (ACA). The ACA is the largest expert advancement association for angels on a global basis, with more than 14,000 private backers and more than 250 angel gatherings and licensed stages. The ACA operates in the U.S., Canada, South America and the Middle East.
Angel Messenger Forum (AMF). New companies looking for equity financing of $100,000 to $1 million can use the AMF to make introductions to pre-screened private and corporate angel backers.
Small businesses seeking angel funding can also use social media to find good angel investment candidates. LinkedIn, in particular, can be a gateway to angel investors—just use the search key to find angels operating in your local area.