Among various forms of investment, angel investing is a high-risk, high-reward avenue. It involves investing your own money in early-stage companies with the hope that they grow into highly successful businesses. Angel investors may require significant upfront capital and the willingness to take on substantial risk. To effectively navigate this terrain, understanding the roles of an angel investor, as well as acknowledging the possible risks and rewards, can help you make informed decisions about your investments. A financial advisor can help you determine whether you’re ready to become an angel investor.
What Is Angel Investing?
Angel investing is a strategy in which an individual invests their own capital into a fledgling business, usually a startup, in exchange for ownership equity or convertible debt. The principal goal of these investments is to see these young companies thrive.
Angel investors typically step in when the startup is too small or risky to draw traditional venture capital. Angel investments generally require patience due to the time it can take for a startup to grow.
Google is one notable example of a startup that had an angel investor. Andy Bechtolsheim, one of the co-founders of Sun Microsystems, wrote a check to “Google, Inc.” for $100,000 in 1998 before it was even officially a company.
Requirements to Become an Angel Investor
Becoming an angel investor is not a path everyone can or should take. Yes, it demands a generous pool of disposable income, but it also requires a comprehensive understanding of business principles and a readiness to shoulder substantial risk.
Successful angel investors possess more than just financial capacity. They often have deep knowledge of specific industries, excellent networking abilities, patience to wait for returns, and the skill to assess a company’s potential. Take Howard Schultz, the former CEO of Starbucks, as an example. When he became an angel investor, he leveraged his deep knowledge of the coffee business to invest in companies like Dolly’s and MOD Pizza.
How Much Money Do You Need?
Angel investors typically invest anywhere from $5,000 to $100,000 per company, according to the Angel Capital Association, a professional society of accredited angel investors. However, some angel investors may invest more, up to several million dollars.
At the end of the day, there is no concrete minimum or maximum investment an angel investor can make. The actual amount can vary based on the individual’s income level and risk tolerance.
Do You Need to Be Accredited?
While the Angel Capital Association recommends that startups work with accredited investors, you technically don’t need to be an accredited investor to make an angel investment. Thanks to the Jumpstart Our Business Startups (JOBS) Act, non-accredited investors can invest in startups through crowdfunding platforms.
However, angel investors who wish to become accredited investors will need a net worth of at least $1 million (not including their home) or $200,000 in earned income ($300,000 for married couples) in each other two previous years. Investment professionals in good standing with a Series 7, Series 65 or Series 82 license may also qualify as accredited investors, as well as finance professionals.
Education and Experience
While there is no formal academic path to becoming an angel investor, a strong educational foundation and knowledge base can significantly enhance an individual’s ability to navigate the complex world of early-stage investing. Educating yourself about the industries in which you plan to invest is vital. Staying updated on emerging trends, market dynamics, and technological advancements can help you identify high-potential startups with viable growth prospects.
Many successful angel investors also have entrepreneurial backgrounds themselves. Having experienced the challenges and triumphs of running a business can lead to more strategic and successful investments.
Risks of Becoming an Angel Investor
Though angel investing can yield substantial rewards, it’s important to remember the significant risks it comes with. Citing data from the Bureau of Labor Statistics, the Chamber of Commerce indicates that about one in five small businesses fail within the first year of launch, while approximately 65% are out of business within 10 years.
However, this doesn’t necessarily mean such investments will fail or are categorically a wrong choice for everyone. Having a high risk tolerance is beneficial, and a well-strategized risk management plan.
There are other potential risks, too. For example, some startups can take longer than expected to scale while others may require additional funding rounds, which can dilute the ownership of early investors.
Differences Between an Angel Investor and a Venture Capitalist
Angel investors and venture capitalists both provide capital to businesses in exchange for equity in those enterprises. However, there are some key distinctions between these two types of investors.
- Source of investment: While angel investors invest their personal wealth in businesses, venture capitalists invest pooled funds from various sources like pension funds, insurance companies and high-net-worth individuals.
- Timing of investment: Angel investors typically target early-stage companies and startups. Venture capitalists, on the other hand, look to invest in later-stage businesses that demonstrate the ability to grow even more.
- Size of investment. Venture capitalists typically make larger investments than angel investors.
Bottom Line
Angel investors use their personal wealth to invest in startups and other promising early-stage businesses. While angel investing can certainly be rewarding, both financially and personally, it comes with significant risks. Many small businesses fail, while others may not grow as quickly as an investor hopes.
Investing Tips
- Whether you’re a traditional investor or an angel investor, a financial advisor can help create a plan for your money. Finding a financial advisor doesn’t have to be hard. SmartAsset’s free tool matches you with up to three vetted financial advisors who serve your area, and you can have a free introductory call with your advisor matches to decide which one you feel is right for you. If you’re ready to find an advisor who can help you achieve your financial goals, get started now.
- Knowing how your investments can potentially grow over time is vital to making portfolio decisions. SmartAsset’s investment return and growth calculator can help you estimate how much your investments could be worth given a specific rate of return and time frame.
Photo credit: ©iStock.com/Drazen Zigic, ©iStock.com/shironosov, ©iStock.com/VioletaStoimenova