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Is Angel Investing a Smart Way to Build Wealth?

Investing is the linchpin of any sound wealth-building strategy, but that doesn’t mean you have to limit yourself to playing the market. Angel investing is another way to potentially reap some major returns but like anything else, there’s a certain amount of risk involved. Let’s take a look at what angel investing is and how it works to help you decide whether it’s worth the gamble.

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What Is Angel Investing?

In the simplest terms, angel investing involves putting private money into one or more startup companies. In exchange for fronting some of the cash that a company needs to get up and running, you receive a stake in the business.

If you decide to sell your share back to the company at some point, you’ll be entitled to whatever percentage of the company’s value you own. So, for example, if you have a 10% stake and the company is worth $3 million, you could get a $300,000 pay out. On the other hand, if the company’s worth nothing, you’d end up with a big fat zero.

Can Anyone Be an Angel Investor?

Is Angel Investing a Smart Way to Build Wealth?

The 2012 JOBS Act made it easier for individuals to become angel investors. But meeting certain guidelines is required to get in on these kinds of deals. Specifically, you have to meet the U.S. Securities and Exchange Commission’s definition of an accredited investor.

To do that, you have to earn $200,000 or more per year ($300,000 if you’re married and your spouse works) or have a net worth of more than $1 million. You have to hit that income threshold consistently for at least three years in a row to qualify.

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The amount of money you need to fund a deal can vary pretty widely. Depending on how much cash you have on hand, you might be able to invest in a company with as little as $15,000 or $20,000. Other deals, however, might require a minimum buy-in of $50,000 or more.

What Are the Benefits of Being an Angel Investor?

Being an angel investor has tangible and intangible benefits. For one thing, you get the satisfaction of knowing that you helped an up-and-coming business take off, assuming that the company you’re investing in succeeds.

The other obvious advantage is the potential to cash in on some sizable earnings if you pick a winner. The larger your equity stake in the company, the bigger the return you stand to earn if the company’s value increases substantially over time.

What Are the Drawbacks?

Is Angel Investing a Smart Way to Build Wealth?

Angel investing can be a hit-or-miss exercise and in some ways it’s riskier than investing in stocks. With the stock market, you can look back at the historical returns for a particular investment to get an idea of how it might perform in the future, though past performance is not a guarantee of future results. You can also invest in index funds that track the overall market. With a brand-new company, you really don’t have anything to go on other than sales and revenue projections that aren’t set in stone. Companies aren’t required to pay back money received from angel investors, so you stand to lose big if the venture fails.

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How Can You Protect Your Investment?

If you’re thinking about getting into angel investing to build wealth, there are a few things you can do to hedge your bets. First, you’ll want to research investing opportunities as thoroughly as possible. If you’re unsure about where to start, you can search for an angel investing group in your area. These groups can be a source of invaluable help when you’re a new investor.

Next, you can gauge how much money you can reasonably afford to lose if the investment doesn’t pan out. If it’s your first time, you might want to start by investing a smaller amount of cash.

Finally, you don’t want to put all of your eggs in one basket. Before you jump into the angel investing pool, it’s best to make sure you’ve got a well-rounded portfolio of other investments. The more diverse your investments are, the easier it’ll be to cushion the blow if your angel investment doesn’t pan out.

Photo credit: ©iStock.com/Horst Gerlach, ©iStock.com/PeskyMonkey, ©iStock.com/calogero

Rebecca Lake Rebecca Lake is a retirement, investing and estate planning expert who has been writing about personal finance for a decade. Her expertise in the finance niche also extends to home buying, credit cards, banking and small business. She's worked directly with several major financial and insurance brands, including Citibank, Discover and AIG and her writing has appeared online at U.S. News and World Report, CreditCards.com and Investopedia. Rebecca is a graduate of the University of South Carolina and she also attended Charleston Southern University as a graduate student. Originally from central Virginia, she now lives on the North Carolina coast along with her two children.
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