What Is an Angel Investor?

Man considers investing in a new business
•••

FG Trade / The Balance

Investors have many different options when it comes to choosing what they want to invest in. Investing in startups, for example, is different than investing in other types of businesses, as startups don’t yet have the revenue and proven sales record of more established businesses. If you invest specifically in new startups that have yet to really establish themselves, you are considered an angel investor.

The fact is that most startups will fail. The historical trend is that 20% of startups will fail within the first year, and about 50% will fail within five years. After six years, only 40% of those new ventures will continue to operate.

However, that doesn’t stop people—specifically titled angel investors—from investing in startups that are still finding their way in their designated industry. Learn who angel investors are, as well as whether or not angel investing is the right move for you.

Definition and Examples of Angel Investors

Angel investors are different from other types of investors in that they invest specifically in new startups that have yet to really establish themselves. Angel investors provide the first round of funding of outside capital, meaning they are the first individuals to invest in the business aside from the founders themselves or the founders' close friends and family.

In 2019, total angel investments amounted to $23.9 billion, an increase of 3.2% over 2018, according to the Center for Venture Research at the University of New Hampshire.

Not just anyone can be an angel investor. Typically, angel investors are wealthy individuals who use their personal assets to invest in startups. And out of a desire to protect the investing public from fraud, angel investing is generally limited to accredited investors who are legally defined at the individual level by specific training or financial means.

How Does Angel Investing Work?

Angel investors will often target companies they believe will provide at least a 10-times return on their investment over a five-year period, with a normal investment amount falling around $600,000.

To find opportunities, investors can network with other angel investors, or use a digital search platform like the Angel Investment Network to find companies that are seeking financial advancement. After identifying potential targets and before investing in a company, angels will perform their due diligence by reviewing information the firm has available, such as background on who the founders are, industry trends, or macroeconomic information.

Startups have not gone public yet, so if you’re looking to invest, you can’t look on the open market and buy shares directly, as in the case with a publicly traded company.

Generally, the investor receives the following:

  • Partial ownership of the company. If you’ve seen an episode of Shark Tank, this is the “stake” they are talking about in the negotiations—how much ownership over the company an investor will maintain. The percentage typically falls between 10% and 30%.
  • A convertible note. This allows the investor to exchange the note for common shares when they are eventually issued.

The deal could be a combination of ownership and convertible securities, as well. The goal then is for the company to grow until it becomes the target of an acquisition or the owners choose to take it public, whether that be with an IPO, through a SPAC, or another method.

Angel investors provide more than just funding. Angel investors can bring experience, expertise, and a preexisting network from their given industry or background, further helping the business become successful. It is not uncommon for angel investors to take an active role in growing the business and ensuring it becomes successful, as the investors’ goals are typically aligned with the business they choose to invest in.

What Are Angel Groups?

Angel investors can either act independently or as part of a larger group. Angel groups are associations of individuals that pool their money together and decide as a group which startups will receive the investment. This can be helpful because the angels have one another to share ideas with and get different perspectives on potential investment targets during the due-diligence process.

The Angel Capital Association (ACA), the official industry collective of the largest angel investor groups in the U.S., has more than 400 angel groups in its database. According to the most recent data from the ACA, the average member angel group has 42 members involved and invests a total of $2.42 million, allocated across 9.8 deals per year.

How To Become an Angel Investor

If you think you may be interested in becoming an angel investor, there are a few basic steps to follow.

Verify You Are Eligible To Be an Angel Investor

The first step is to make sure you qualify and are eligible to become an angel investor. As previously mentioned, angel investors generally need to be accredited investors. The requirements to be an accredited investor can be found in Rule 501 of Regulation D of the Securities Act of 1933.

Find Startups Looking for Angel Investors

There are several digital platforms that help connect angel investors to startups looking for funding. Platforms such as SeedInvest and Angel Investment Network could be a good place to start.

Joining an angel group may be beneficial if you are serious about angel investing, as the various members can share their experiences and guide you through the process.

Present a Term Sheet 

Once you’ve decided on an investment amount and the business you want to invest in, you’ll need to work out the details of the arrangement with the founders. Deals are negotiated between angel investors and funded startups. Again, that is unlike a typical investment when you simply buy stocks and bonds on an exchange. You can propose a deal to a target startup with a term sheet, which outlines the details of the deal and brings lawyers in the process to determine the relationship between the company and its investors.

Is Angel Investing Right for You?

Angel investing is very different from investing in typical securities like stocks, bonds, and mutual funds. It’s much riskier. Most angel investments fail, and the majority of an angel investor’s return comes from just a few successful investments.

If you decide to invest in up-and-coming startups, keep in mind that you will likely need to be able to financially withstand several failed investments before turning a profit. As with any investment choice, make sure it fits into your plan, and don’t overextend yourself.

The Balance does not provide tax, investment, or financial services and advice. The information is being presented without consideration of the investment objectives, risk tolerance, or financial circumstances of any specific investor and might not be suitable for all investors. Past performance is not indicative of future results. Investing involves risk including the possible loss of principal.