What is an angel investor?

Angel investors are early-stage private investors who invest in startups and small businesses with the potential for high returns. These investors usually expect a generous rate of return (ROI) for these deals, given the higher risk at the early stages of a company.

Understanding angel investors

As a form of equity financing, angels invest their own capital into early-stage or small companies that meet certain criteria, in exchange for equity in the company. 

Unlike Venture capitalists, which are institutional investors, angel investors are placing their own funds and it is much more personal. Angels usually invest earlier than venture capitalists, and they want to see evidence of dedication, talent, and resilience on the part of the founders they are investing in.

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Origins of the term “angel investors”

For those tuned into the world of arts and entertainment, it might help to think of angels as “patrons.” After all, the term is derived from New York City’s Broadway. When a play was at risk of shutting down due to lack of funds, wealthy people would pledge their own money to keep the show going, find an audience, and have a second chance at success. More specifically, the term “angel investor” can be traced back to the 1978, when William Wetzel, founder of the Center for Venture Research, completed a study on how entrepreneurs raised seed funding. He described the people who financially supported entrepreneurs as “angels”.  

How can angels help early stage businesses?

One of the most difficult challenges for any new business is finding enough funds to start growing in the first place. Raising money from angel investors can be mutually beneficial: ambitious founders are financially supported by an experienced investor who believes in them. The angel owns a piece of the company, shares their insights and experience and  can potentially reap large financial rewards further down the road, if their venture is successful.

How does angel investment differ from a business loan?

Business loans provide founders with a fixed amount of money, usually based on their credit history and financial means to repay the loan. There are also contracts involved, which require the founders to repay the business loan in full after an agreed-upon amount of time, with added interest. Business loans may be beneficial for founders who wish to retain control of the company and its direction, by keeping as large a stake in their startups for themselves as possible. However, loans from banks and other lenders are increasingly hard to come by for startups and small enterprises.

Taking investment from angel investors is very different from taking a loan. Importantly, founders don’t need to pay angels back if their company fails. Of course, angels and entrepreneurs do everything they can to avoid this.

Angels have a vested interest in seeing the company they invest in succeed, so they’re often willing to go out of their way to help - not just with money, but sometimes even creative input of their own, sharing their experience, advice and insights, as well as making useful introductions. That’s part of the reason why angels can receive such large stakes in the companies they invest in. Founders aren’t just getting capital - they’re getting connections and advice through a passionate key addition to the team.

Advantages of angel investment

• The sky’s the limit: loans from a bank can be very hard to access. With angel investment, there’s usually no cap in the funding requirement. It’s up to an agreement between the founder and the angel. As long as angels are willing to put up the  money, there’s nothing stopping them from putting additional investment tranches at a later stage in their favourite startups, upon reaching certain milestones.

• Aligned interest: Angels have a vested interest in their investments succeeding, so they’ll want to  see your company succeed almost as much as you do. Viewed from this perspective, you can view this as much more of a partnership. A win for you is a win for the angel. 

• Networking: Many angels have great professional networks. This means they can often tap into the resources of  other investors to invest alongside them. This reduces their risk but also increases your rewards since you may benefit from broader experience and financial clout. Or the introduction could bring specific expertise, such as a marketing expert who might be able to help you promote your new business.

Cons

• Reduced control: legally, angels are part owners in your business. As such, finding the right angel investor isn’t just about whoever has the most money. It’s about shared vision. You should only enter into agreements with angels you can trust and have done your own due diligence on. Not only will the right investor have access to sensitive information about your company, but they’ll need to be on the same page about key decisions, as well as share the vision outlined in your business plan. Make sure you have adequate provisions in your shareholder agreement to protect your investors’ interests, as well as your own.

• A smaller slice for you: when it comes to collaboration, you should prepare for everything, especially success. Make sure you’re happy with the angel’s percentage of ownership. The more your company makes, the more the angel makes, so you should have a sense of how large a slice of that pie you’d like to keep to yourself after calculating various funding rounds out into the future, taking into account possible VC funding rounds and top-up rounds.

• Answering to angels: some founders find angels frustrating, because these investors expect a great deal and the entrepreneur is taking the most risk at the company’s beginning. So they want to be sure they’re receiving all the money they’ve earned from the agreement. They want to be sure their time and money is paying off, and may even set time frames for when they’d like to see a certain amount of profit over the years.

Typical sources of funding

Friends and family

If your loved ones are in a financial position to do so, they may want to become an angel investor in your enterprise. Just be careful about how this affects your relationships. Be frank about the risks involved. As happy as they may be to help now, nothing complicates relationships like money.

Wealthy individuals

Almost anyone with a large enough net worth is a potential angel, and you may already be acquainted with some wealthy people. You may also meet them through your local chamber of commerce, and they might find you through their personal network or word of mouth. Many wealthy individuals are excited to invest in startups.

Angel syndicates

These are becoming more popular among angels, as it allows them to invest even more than they otherwise could. Syndicates typically have a lead investor who organizes the group and decides on investments. Other angels can join the syndicate, and all the money is pooled together into one investment. Typically syndicates operate by using what are called “special purpose vehicles” (SPVs). These are usually LLCs that exist solely to handle the syndicate’s investments.

Communicate before deciding

Besides money, what else does your would-be angel bring to the table? For example, do they have a relationship with any suppliers? Do they agree with your business plan? Do they share your beliefs about how you’d like your business to be run? Perhaps more importantly, do you get along? You’d be working closely with this person, so it’s important not just to be philosophically aligned, but enjoy spending time with each other.

Exit scenarios

Angels make money when an investment “exits”. Typical exit scenarios include an IPO or an acquisitions. These exits usually make up a small percentage of an angel’s investment portfolio, but provide nearly all the returns. 

Ultimately an angel investor is judged by the number of exits they have in their portfolio. It often takes 5-10 years, or sometimes longer, for an angel investment to mature enough to exit.

Key Takeaways

Angel investing is a high risk, high reward endeavour for both founders and investors. Angels can be tremendously helpful to entrepreneurs. If you need to raise funds for your startup, and don’t know where to begin, angels are an excellent place to start. Most cities have angel investing groups which you can find by doing some searching around. 

Read more about how to find investors for your business.

Learn more about angel investing portfolio construction:

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This educational article is provided by Republic to help its users understand this area of the market, it should not be construed as investment advice as it is impersonal, disinterested and was produced by Republic for Republic’s users, without remuneration received or expected.