Editor's note: This article was originally published by GoingVC and has been reposted with their consent.
Angel investors throw a lifeline to young startups when other institutional actors like banks and VC firms won’t.
Angels are high-risk, high-reward private investors who dedicate their time and money to high-growth businesses in exchange for equity down the road. They typically enter at the pre-seed and seed stages and commit capital as needed in subsequent rounds.
By investing in companies that are just getting off the ground, not only are they aptly named, these investors are playing an increasingly significant role in entrepreneurial finance.
Angels vs. Venture capitalists
While both participate in early stage private investing, the difference is largely motivational.
Unlike other capitalists, angels are not in it just for financial gain. Part of the appeal of angel investing is the opportunity to contribute experience, skills, and expertise. The individuals that adopt these roles are more often than not wealthy who have experienced great success in the business arena looking to help other entrepreneurs do the same.
While the degree of involvement varies, there is an expectation that angels offer up their knowledge, skills and networks to the entrepreneurs they support. That is why angels are willing to take on so much risk—the rationale being that their involvement will (hopefully) positively influence the startup’s success.
That’s why startups receiving angel investments are 20-25% more likely to survive after four years and 16-19% percent more likely to grow to 75 employees, as the Kauffman Foundation reports.
VCs, on the other hand, as institutional players, are far more risk-averse and often times less hands-on. As fund managers, venture capitalists are concerned with growing returns on the money they invest on other people’s behalf. They will generally invest in companies with proven business models, and require some initial validation before cutting a cheque.
Can anyone become an angel investor?
Angel investing breaks from the traditional investor profile that has long dictated who gains access to high-altitude investing.
Quite unlike the Old Boy’s Club that is VC, a diversity of backgrounds are represented in angel investing. Angels can be wealthy family and friends, C-Suite executives, and highly successful industry professionals, all of whom leverage their own wealth and business acumen to support new businesses.
While they hold little in common, there are a few qualities that are especially angelic. Successful angel investors are:
Calculated risk takers. Angels draw on their intuition and take chances on otherwise unvalidated business models. Being able to do so requires not only some first-hand experience building a business, but often in entrepreneurial fundraising and financing as well.
Committed and available. For some, being an angel is a full-time job. Whether or not you choose to make it a career, the guidance and mentorship that comes with the role does present a serious commitment.
Patient. More often than not, angel investors will wait 7-10 years before they can cash out at the company’s first (or next) liquidity event. The best angels plan around their investments illiquidity, and focus instead on helping their ventures reach their full potential.
Focused and Up-to-date. Angels typically hail from a specific industry or sector, or have extensive experience with certain products or service offerings. To make prudent deals and help grow their portfolio companies, angels stay current on the latest trends and events in their respective markets.
And perhaps most importantly, angels are those who can afford to lose money.
Angel investing financial requirements
Given the significant risk, this asset class usually constitutes a small percentage (typically 10%) of one’s investment portfolio.
While there isn’t a minimum or standard amount, the average angel investment is $77,000 with typical amounts invested ranging from $10,000 and $500,000. Keeping in mind that most angels diversify their portfolios by investing in multiple companies at once, and typically also invest in later rounds, building a strong portfolio takes serious money.
Many of these investors meet the SEC’s “Accredited Investors” standard. To achieve accreditation as an angel, an investor must have a yearly income of at least $200K, a net worth of at least $1 million, or an LLC or Trust worth over $5 million.
While accreditation is not a prerequisite for angel investing, it can be harder to access the same opportunities without it. Regulation D 506(b), for example, limits the number of non-accredited investors that can invest in a given company to 35. That being said, those working with smaller sums are barred from participating in private investments.
There are no restrictions placed on the 35 non-accredited investors. To be one you just need a relationship with the company and founder, and you should of course have the capacity to evaluate the investment you’re making.
To syndicate or not to syndicate?
Angels don’t always act independently.
Given the risks, angel syndicates have become an increasingly popular angel investing model. These are groups of accredited investors that jointly syndicate investments.
These arrangements consist of an experienced and well-connected lead who often has fundraising experience who will effectuate a deal on the group’s behalf in exchange for carry–a percentage of profits that each member pays the lead.
Doing so distributes both the risk and due diligence work. By partnering up on deals you are not only tapping into the group’s collective knowledge base when vetting deals, but into your co-investors networks as well, thereby increasing your deal flow for more effective sourcing efforts.
This may be an especially attractive approach for those looking to make smaller financial commitments, and inexperienced investors interested in learning alongside other angels before striking out on their own.
You can look for groups with whom you align at directories like the Angel Capital Association, AngelList, The Syndicate, Angel Resource Institute, and FundingPost.
Building your angel investment portfolio
Based on what’s been said so far, is angel investing for you? If it is, you’ll need to develop a robust process for sourcing deals, conducting due diligence, and managing your investment portfolio. Here are some steps that will help you do so.
1. Know your ‘why’
Start by challenging some assumptions you might have about this asset class. If you’re in it for high returns then it might not be the right fit. Those that can stomach the risk and go years without seeing a return on investment are those who want to help other entrepreneurs succeed.
If the prospect of growing small businesses excites you, consider where you’d have the biggest impact.
What unique network, skills and experiences do you bring to the table and, accordingly, which opportunities are you best aligned with? Alongside your capital, how much time are you willing to invest in the company?
Remember: anyone can cut a check, but not everyone has the right background and skills to help a B2B fintech enterprise or a medtech product reach its full potential. Determining where your unique profile fits best will help narrow your search to those opportunities where you’d have maximal impact.
2. Establish your deal flow
Once you have an idea of what you’re looking for, you’ll want to establish high-quality deal flow. That is, you’ll want to increase the number of potential investments that come across your desk.
Greater exposure to deals will not only give you access to more investment opportunities, but can help you develop an eye for high quality deals when they do come your way.
To achieve this you’ll need a robust deal pipeline.
Your preferences and potential fit you should dictate not only what you’re looking for, but where you’re looking. There are a number of great sources for investment opportunities, but what matters is that you’re associating with capitalists, angel groups, universities, incubators, and industry professionals heavily involved in the markets that interest you.
Establishing deal flow can be passive.
This largely involves plugging yourself into–if you are not already–the sectors and industries you’d like to invest in. By consuming the latest content, meeting founders, and joining communities and forums for early stage investors that send prospective startups and deals to you like our very own GoingVC Angels.
Or it can be active.
You might instead choose to create your own content, join an advisory board or participate at an accelerator on a volunteer basis–none of which require any financial commitment. For those looking to start small, the good news is that building a network that allows you to learn, see intriguing deals, and get closer to founders is free! You don’t need to wait until you’re ready to make investments to get started.
3. Understand the risks and manage expectations
Early stage investing is not for the faint of heart.
While most enter a deal knowing they could lose it all, angels are not in the business of wasting capital. Setting objectives for your portfolio is an effective way to professionalize your approach. Consider the following:
- What is a reasonable minimum realized cash on exit returns across the entire portfolio?
- What percentage of invested capital do you expect will be realized as total losses?
- And lastly, how long, on average, will you wait for exits?
While these objectives do little at the outset of a deal, where a startup’s success is unpredictable, they can be used to benchmark the portfolio’s performance to date and assess your overall investing strategy.
4. Assess prospective deals
As with any investment, you of course want to determine whether this is a team that has what it takes, whether they are tapping into a promising market and whether there is a solid, differentiated product on offer.
At this stage, founding teams may have very limited performance records for your examination. Put the financials aside and ask to be walked through the product.
You should also make sure your bases are covered. Review the deal terms for red flags such as exaggerated valuations, or pricey convertible notes and SAFEs. Ensure that the founders agreements with share vesting, IP assignment and non-disclosure provisions so that the company can weather any changes in leadership.
However, determining whether the venture is both viable and high-potential is only part of it. Most importantly, consider the values of the founders and their vision. The most successful and rewarding angel investments take place when angels connect with their companies.
GoingVC’s Screening Scorecard for both angel investing and VC investing provides an overview of what you should look out for when conducting due diligence.
If you're interested in becoming an Angel Investor, start by learning, building your network and contributing your time as an advisor. All of which will help you gain the skills and experience you’ll need when the right opportunity comes along!