The thrill of investing has become very real and desirable to many people. Through the influence of shows like Shark Tank and the newfound popularity of investing using applications like Robinhood, many people think that they can become investors. The truth is, the average person can become an Angel Investor. But, investing in a business is not just a fun hobby; it is a significant decision and often a lifestyle choice.
As with any entrepreneurial activity, there are a few traits and financial requirements that a person must have to successfully be an Angel Investor. While anyone with the means to invest could become an Angel Investor, not everyone has the experience, qualities, and drive required for success.
The following guide will explain some of the requirements and tips for prospective Angel Investors, and help you decide if this is the right path for you, or if there is a better way for you to invest in small businesses.
What is an Angel Investor?
An Angel Investor, in short, is an individual who gives money, time, and advice to entrepreneurs starting (or growing) their business in exchange for equity in the company (or another form of return). Angel Investors can also be referred to as “seed” investors if they are part of the first round of funding, but this article will continue to use the term “Angel.”
Because this is done privately (not publicly like a shareholder would buy stock, for example), there are many ways to arrange this exchange. The terms and conditions depend on both the needs of the investor (who supplies the capital—and is thus a capitalist) and the entrepreneur (who needs the funding and additional help to grow a successful enterprise).
There is no set amount that makes an investment an Angel investment. However, the average investment is $77,000. Furthermore, many entrepreneurs will seek the help of multiple Angels to meet their capital requirements.
An investor of this sort is called an “Angel” because they often lend to entrepreneurs to whom banks will not give a loan, or whom venture capitalists deem too risky. In this way, the Angel allocates assets, as a bank or other financial vehicle would, but he is less risk-averse for non-monetary reasons.
Tip: Angel Investing is not as simple as funding a 401k and waiting for it to grow. Although it is not typically considered “active investing,” there are requirements of the Angel that go far beyond simple monetary commitment.
Angel Investing can be challenging, and it takes a particular type of person to do it well, but the rewards can be satisfying both financially and intellectually.
What is the Difference between an Angel and a Shark?
The role of the Angel Investor extends beyond his checkbook (this is one of the defining aspects of an Angel as opposed to any other type of Capitalist). He is to be a mentor and a guide to the entrepreneur, assisting with business details and planning.
A Venture Capitalist (sometimes known as a “shark”), however, typically plays a slightly different role. Venture Capitalists manage Venture Capital Firms. They act as a decision-maker and spokesman for many investors. Because of this, they typically are less involved in the mentorship and character development of the entrepreneurs they sponsor, and if they are involved, it is only in the actual business operation of the company.
Furthermore, Venture Capitalists typically have more money to invest because they represent many investors rather than just one portfolio like an Angel. Also, Venture Capitalists are generally more risk-averse and frugal than Angels, but willing to do multiple rounds of funding for the businesses they do choose to fund.
Financial Requirements for Being an Angel Investor
First, when one is thinking about investing in this manner, it is crucial to understand the financial requirements of an Angel. Angel Investors invest their own money (and time and effort) into the business, which means that one needs to have the cash before entering the market.
While there are different levels of investing, and each company has its own unique needs, only people with enough capital can become an Angel Investor. The typical amount invested in one company is between $10,000 and $500,000, and most Angels invest in multiple companies to remain diversified.
Additionally, this type of investment is not recommended to take up more than 1/10th of one’s portfolio.
Also, it is common for Angels to invest multiple rounds of capital into a company. This means that you might make a $50,000 investment followed by another $25,000 investment in two years. Or, it could happen that the company only realizes later they need more capital and will then ask their Angel for an additional round of funding years into the relationship.
Tip: Before investing all of your savings into one start-up, think about diversification and risk. While anyone with a few thousand dollars can certainly become an Angel, it doesn’t mean that this is the best way to start investing.
Today, it is often, but not always, the case that Angels are SEC “Accredited Investors.” In other words, this means that they have a net worth of at least $1 million, an LLC or Trust worth over $5 million, or an income of at least $200K. That being said, more stipulations do exist.
Being an accredited investor can give one access to certain financial vehicles and means of investing. In the United States, it used to be the case that Angel investing was limited to accredited investors only.
As of 2013, the JOBS act lifted restrictions on Angel investing, making it an accessible investment possibility for the common man. Some argue that it is good to allow anyone to become an Angel. But, the ramifications of lifting this limitation are that inexperienced investors with little capital can now enter the market and can cause assets to be misallocated.
Character Traits of an Angel Investor
Financial feasibility aside, it takes a particular type of person to be an Angel. Because Angels are independently funding and guiding the entrepreneurs, there are certain character traits the investor must have to fulfill his role as an Angel:
An Angel is a Risk Taker.
It is the nature of Angel Investing to be risky, because one is investing in a small, growing, or otherwise untested enterprise.
Furthermore, the entrepreneurs who look for funding from Angel Investors are there precisely because they need something that a bank cannot give them. Getting a loan from a bank would be much easier, in most circumstances, but for whatever reason, the bank has (or would) deemed them to be too risky of a loan.
Angels are less risk-averse than banks or other financial intermediaries typically are, and thus they would be willing to take on this high-risk-high-reward gamble. More on why Angels are bigger risk-takers later, but for now, understand that being an Angel means you must assess risk and sometimes make risky investments.
An Angel is Helpful.
Because an Angel does not only provide monetary help to the entrepreneur, but also advice and guidance, an Angel must have the drive to be helpful and to mentor. To be an Angel, and not just a faceless banker or Venture Capitalist, one must know the ropes and be able to teach them to their entrepreneurs.
Angels must want to help their entrepreneur; otherwise, they would only fulfill the monetary side of Angel Investing, and not the full mentor and capitalist role of an Angel.
An Angel is Current.
This means the investor is passionate about his field and interested in what the current events and trends are.
First, to make prudent investment choices, an Angel must know the market and be able to vet the entrepreneurs who come to him for funding adequately.
Secondly, as mentioned, an Angel is helpful, and thus must know, understand, and be on top of the current market. Angels typically, and should, invest in businesses that they are (or were) a part of, and the Angel must keep up with the times so that they can be successful before and after striking a deal with an entrepreneur.
An Angel is Patient.
As a mentor, an Angel must be able to understand and guide their entrepreneurs patiently. Being an Angel means you form a relationship with your entrepreneur, unlike what would happen between a bank or shareholders and a businessman.
Furthermore, as will be discussed below, Angel Investing requires a lot of time, and thus patience is an important character trait of successful Angels.
An Angel is Prudent.
Good judgment is a must for Angels. They need to be able to assess risk, analyze markets, and understand the needs of all parties involved. They need to protect themselves, and the economy, from poor investments which lead to wasted capital. Angels must have the ability to use both learned and natural wisdom when making offers.
Other Qualities of an Angel Investor
Aside from the capital and character requirements, there are other qualities (both inherent and changeable) of investors, which can make them more or less suitable for Angel Investing.
Location is important because of the interaction between the Angel Investor and the entrepreneur. A lot of meetings and hands-on visits would not be possible if the two were far apart. This isn’t a totally defining quality in the modern world of travel and the internet, but it is something to think about.
Gender and Race
Gender and race play a role in Angel’s vetting processes—as much as people say or wish it wasn’t so. Now, this is less important when deciding to be an Angel than it is when asking an Angel for help, but it is certainly worth noting when researching Angel Investing.
Note: This study, “Angels or Sharks? The Role of Personal Characteristics in Angel Investment Decisions” by Thomas Boulton, Thomas Shohfi, and Pengcheng Zhu, shows that Homophily (preference for similar people) influences Angels’ decisions. That is to say, deals are more likely between Angels and businesspeople of the same gender and/or race.
Experience in Business
Business experience is a two-fold requirement for an Angel. A mature Angel can help a novice businessperson by offering hard-earned advice and mentoring; part of the reason why entrepreneurs go to Angels is to have access to the Angels’ connections, wisdom, and real-world skills.
Secondly, the Angel with personal experience can judge a prudent investment and market better than one with no business background.
Experience in Investing
This is equally as important as experience in the business world because an Angel must be able to judge a good investment, calculate returns, and create a reasonable offer for both himself and the entrepreneur.
Even with no experience in Angel Investing, a seasoned capitalist will know who is a good investment and how to make a good offer, while someone investing for the first time would be better off using a more structured financial vehicle to invest.
Social Network and Reputation
Knowing a lot of people—both in business and in finance—is vital to have success as an Angel.
On the business side, you would want to have good connections to local businesses, know the local market well, and have a trustworthy reputation. You need to be in good standing as a person and have a history of following through and providing the necessary capital.
You want worthy entrepreneurs to come to you for funding, not someone else. There are a lot of Angels and Venture Capitalists in America, and to stand out to the qualified applicants, you have to give them a reason to ask you and not someone with more experience, connections, or a better investing record.
You need time—both for initial research as well as time to spend with the entrepreneurs one chooses to invest in.
A wise Angel puts a lot of effort into vetting applicants for funding to prevent losses in the future. Furthermore, once a funding agreement has been reached, an Angel needs to keep in contact with his entrepreneurs and assist them with their business plans, marketing, management, or other facets of the business.
Thus, many Angels are retired or part-time businessmen themselves because of the time required both before and after the initial funding is made. Finally, the payoff from an Angel Investment occurs when the business is sold or merged with another business—this happens roughly 3 to 10 years after your initial investment.
This means that there are not only hundreds of hours required for this investment; you also have to wait for years to see the returns.
Tip: Tucker Max wrote in a 2015 article titled “Why I Stopped Angel Investing (And You Should Never Start)” about the benefits and the hardships of being an Angel. He emphasized two main points:
- Firstly, it is challenging to be a financially successful Angel.
- And secondly, that for the type of person who would be a successful Angel (like he was), it is more lucrative to simply earn money on the market through entrepreneurship yourself, rather than investing in other, younger, less-experienced entrepreneurs.
What Motivates Angel Investors?
Angel Investing is time-consuming, requires skill, and often renders small or no returns. But it is still practiced—why?
Because there are many non-monetary rewards for Angels, the men and women who are Angels are first and foremost looking for investments that will be profitable but are willing to take a greater risk because of social, intellectual, and personal reasons.
- Thrill: As an Angel, one gets to relive the excitement of seeing a small business grow, succeed, or fail.
- Challenge: As an Angel, one acts as a mentor and advisor, and gets to help solve the inevitable challenges small businesses face.
- Charity: For some, it is a good feeling to know they have helped a small business owner, or influenced a community, or changed the world in a new way. As an Angel, you are closer to the business than through other means of investing, and thus this feeling is stronger for Angels than, for example, shareholders.
- Pride: For some, the act of others asking (sometimes even begging) for funding gives them pleasure.
None of these pleasures are quantifiable in monetary terms. Still, the capitalists evidentially value the pleasures more than a potential loss of investment, so it is worth it to them to be an Angel.
Is Angel Investing for You?
The following chart breaks down a list of people who should or shouldn’t pursue Angel Investing:
|Who Should be an Angel
|Who Should Not be an Angel
|Retired Business Owners
|People with the Capital, but who lack Ideas
|People Inexperienced in Business or Finance
With that being said, even if you think Angel Investing is not for you, being more informed and having the right resources can help make investment choices.
How to Start Angel Investing
If you feel that Angel Investing is for you and that you would make a good Angel, there are a few ways to get started.
- Alone: Angel Investing is not as structured as most financial intermediaries are. Therefore, if you can make a connection with a small business owner, have a lawyer draw up a contract based on your offer, and ensure it is a legitimate Angel Investment. Relationships can be made through a local bank, business, Chamber of Commerce, or an infinite amount of other ways.
- Angel Syndicates: These are pools of investors who would like to be Angels, but perhaps lack some of the connections or capital to do it alone. The syndicates connect entrepreneurs with the appropriate (and appropriate amount of) Angels to meet their needs. As an example, AngelList is the world’s largest start-up community.
Other Ways to Invest in Start-Ups
If, after this article and other research, you find that becoming an Angel Investor is not for you, don’t worry! There are many different ways to invest in start-ups and help small businesses.
Depending on your financial status and your availability, the following are a few examples of what one could do for both the personal satisfaction of helping a small company and the monetary rewards possible through the capitalist market economy.
This allows you to support small businesses that are already established and are less risky than Angel Investing. As with all investments, there is still some risk factor, and buying stocks still requires careful thought and planning. However, it is a safer means for you to provide capital to businesses.
Furthermore, it can be done on a much smaller level than Angel Investing and is thus accessible to people who do not have extensive portfolios.
If you are looking to give to people who are working in an industry you are passionate about, or if you are simply trying to help out people in need, consider sponsoring capital (equipment, buildings, training, etc.) or donating to a foundation or non-profit.
This will not necessarily bring in tangible monetary returns, but another arrangement can be agreed upon (perhaps marketing, or an amount of their product) in exchange for the funding. In any case, it will undoubtedly leave you with the knowledge of a conscious investment in a good cause.
This can include lending money to the company directly or buying bonds from them. It is a lower-risk lower-reward method of investing as compared to Angel Investing. But it is still a means of investing in worthy businesses of your choice.
Although your returns are fixed and will not grow with the business, this can be seen as a good thing, because if the company fails or does not grow as anticipated, you still have a legal right to receive your principal plus interest back (or the collateral provided, such as a property via a lien).
Before You Start Angel Investing
As you can see, Angel Investing can have very positive results for both the small businesses and the investors themselves. But, often, this type of investment can lead to a waste of resources.
The point of investment is to reallocate resources to their most productive uses to generate economic growth and wealth for both the entrepreneurs and the capitalists. Financial vehicles (such as equities and bonds) and financial intermediaries (such as banks and markets) help to facilitate the exchange of resources (money or other forms of capital) to entrepreneurs and then transfer the returns back to the capitalists.
There is always some element of risk when investing, as a business faces many predictable and unpredictable challenges that can damage returns. Thus, it has become the job of some to assess risk and determine appropriate interest rates, discounts, and share values. These people (investment bankers, for example) are professionals making these assessments for a living and are therefore naturally more adept at performing this task than most other people.
Angel Investing is done when the professionals (working at banks or other financial intermediaries) deem an investment to be too risky—and then an Angel flies in to take on this high-risk—potentially high-reward—investment.
By investing in these high-risk small businesses, as an Angel, you would be allocating resources to businesspeople who have a statistically high chance of failure (and thus the resources would be wasted, and there would be no return on investment). Whereas if you were to invest in less risky investments, there is, by definition, less of a chance for resource waste.
Imagine a start-up that asks for funding to build a particular machine. An Angel provides the money so that the start-up can buy the R&D, the labor, the metals, the plastics, and the space to build and use this machine. Now say this start-up (as 90% of start-ups do) fails. All of the man-hours, the raw materials, and the land have been wasted, and the economy ends up poorer than it was to start.
Now say you invest that same amount of money in a company with a higher chance of success. It is, therefore, less likely for the material, land, and time to be wasted—and more likely for productivity to cause economic growth.
All that to say: Angel Investing is risky and often leads to wasted capital. That is why it is so crucial for only confident, experienced, and competent people to become Angels.
To summarize, anyone with the financial capabilities and freedom may become an Angel Investor. It typically requires at least $10,000 to be an Angel, but it can often be an investment of hundreds of thousands of dollars, especially if multiple rounds of funding are in order.
Aside from the financial requirements, there are character traits and inherent qualities required to be a successful Angel. These include: patience, experience, prior success, a high-risk tolerance, connections, and more.
The rewards of Angel Investing can be very lucrative; however, the likelihood of such success is low. Angels often engage in this type of investment because of the non-monetary rewards.
Finally, this article should be understood as a very general introduction to Angel Investing, and more research is recommended before entering this field. It is wise to consider all of the requirements and the risks before engaging in Angel Investing, as it is, and always will be, a precarious way to invest.