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what is an angel investor

Angel investor is one of the terms you constantly hear bandied about on the news, in blog articles and maybe even in a few of your favorite movies. But don’t feel bad if you still ask yourself: What is an angel investor?

An angel investor is simply an individual, generally someone with a big base of wealth, who gives money to a business to help it get started in exchange for either ownership equity or convertible debt. A lot of famous companies you’ve heard of, including Facebook, had angel investors early on. This post will take you through the basics of angel investors, including what an angel investor is, the pros and cons of working with an angel investor, who should use an angel investor and how you can become an angel investor yourself.

Angel Investor Defined

An angel investor is an early investor in a company who gives cash to a startup in order to help it get up and running. Usually, angel investors will receive either convertible debt or an equity stake in the company in exchange for their investment. Sometimes an angel investor will be the first person to invest in a new idea. Generally, an angel investment is made on terms that are more favorable to the business than later investment rounds.

Whereas venture capitalists seek to make investments that will produce high returns, angel investors are more focused on making an idea or a founder that they truly believe in get the money necessary to make their dream a reality. For this reason, angel investors are often — though certainly not always — someone the founder of the company knows personally, either through their personal or professional life.

Angel investors must register with the U.S. Securities and Exchange Commission (SEC) as accredited investors. To register as an accredited investor, you must have an income of at least $200,000 per year and a minimum net worth of $1 billion.

Pros of Using an Angel Investor

what is an angel investor

There are a number of upsides to taking money from an angel investor. For starters, money is crucial to a business’ success. Getting an infusion of cash, especially early in your startup’s existence, makes it more likely that you’ll be able to carry out your vision. Secondly, an angel investment is better than a loan. If you don’t have an angel investor, you may need to go to the bank and get a loan. With a loan, however, you’ll need to pay back the bank no matter what happens with your company. If things don’t work out, this can put you in dire straits. An angel investor, on the other hand, gives you money to become part of the company. If you fail, they fail too.

In addition to the monetary benefits of an angel investor, you also get the investor’s expertise. Angel investors often have successful businesses of their own. This means they might have learned some business lessons that can be applied to your startup. When an angel investor chooses to invest in your company, they effectively become part of your team. You can pick their brain and make use of their knowledge to increase your chances of success.

Cons of Using an Angel Investor

There are, of course, downsides to using angel investors as well. For starters, you’ll likely lose some control. When an angel investor opts to invest in your company, they probably won’t just sit by passively — after all, they now have skin in the game. There’s always the chance that your angel investor will have ideas that clash with yours. You may have to deal with potential conflicts and possibly even power struggles if you work with an angel investor.

Using an angel investor also opens up the chance of a potential loss of money down the road. You’re selling part of your company in exchange for the angel investor’s funding.  This means that if your company does end up finding great success, some of the proceeds will go to your angel investor. That’s money that could have been yours if you’d used an alternative funding source.

Last but not least, an angel investor can mean more pressure. When you’re just investing your own money, the pressure to succeed is entirely on you. Once you involve an angel investor, there is suddenly pressure from outside forces, namely the person who trusted you and believed in you enough to invest in your company. That pressure can impact the way you go about building your business.

Who Should Use Angel Investors?

what is an angel investor

Only you can decide if using an angel investor is the right decision for you and your business. As discussed above, there are a lot of pros and cons you’ll have to weigh to decide whether or not an angel investor is what your startup needs. Any type of company can use an angel investor, but technology-driven startups are among the biggest users.

Ultimately, you should use an angel investor if, after careful consideration, you think you’ve found an investor who is a good match for your business and whose investment would make it more likely for you to succeed.

How to Become an Angel Investor

The first step to becoming an angel investor, obviously, is having enough money to be able to invest a decent chunk of change in a company. You’ll likely need at least $10,000, but often much more. You also must register with the SEC as an accredited investor. To be eligible to register, you must meet minimum net worth and income level requirements.

The next step is to identify an investment opportunity and set up a meeting with the company’s founders. There are a lot of guides for how to pick a company for which to be an angel investor. Essentially, it all boils down to making sure you believe in the company’s founder and think that you will work well together. From there, you can negotiate the terms and figure out exactly how you want your role as angel investor to play out.

The Bottom Line

An angel investor can give a startup a chance to get going by providing an infusion of cash early in the company’s existence. There are pros and cons to making a deal with an angel investor. Ultimately, it’s up to each founder to decide whether or not using an angel investor is the right decision. If you are considering becoming an angel investor yourself, find a company with a founder you really believe in — it might even be someone you already know.

Investing Tips

  • Angel investor or not, if you’re looking at how to make the most out of your money, you probably need a financial advisor. SmartAsset can help you find one with our free financial advisor matching service. You answer a few questions about your financial situation and goals. Then we’ll match you with up to three advisors in your area. We fully vet all advisors on our platform and make sure they are free of disclosures. Each of your matches will then reach out so you can discuss working together.
  • Check out how much your investments might be worth in the future with SmartAsset’s free investment calculator.

Photo credit: ©iStock.com/RomoloTavani, ©iStock.com/davidf, ©iStock.com/seb_ra

Ben Geier, CEPF® Ben Geier is an experienced financial writer currently serving as a retirement and investing expert at SmartAsset. His work has appeared on Fortune, Mic.com and CNNMoney. Ben is a graduate of Northwestern University and a part-time student at the City University of New York Graduate Center. He is a member of the Society for Advancing Business Editing and Writing and a Certified Educator in Personal Finance (CEPF®). When he isn’t helping people understand their finances, Ben likes watching hockey, listening to music and experimenting in the kitchen. Originally from Alexandria, VA, he now lives in Brooklyn with his wife.
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