One potential source of funds for new businesses is angel investors: private, wealthy investors who will finance your business in exchange for an ownership stake.
Here’s an overview of angel investors, some pros and cons of this kind of small-business financing, how to determine whether it’s right for your startup and how to bring potential angel investors on board.
Angel investors are typically high net worth people who fund startups or early-stage businesses. Many are accredited investors with a minimum net worth of $1 million or at least $200,000 in annual income. Angel investments can be thousands to millions of dollars, depending on business size and ownership sold.
Angel investors are often accredited investors, which is a designation that requires a minimum net worth of $1 million, at least $200,000 in annual individual income or at least $300,000 in annual joint income (see the Securities and Exchange Commission website for details). People who hold a Series 7 license (a broker license), a Series 65 license (an investment advisor license) or a Series 82 license (a private securities offerings license) may also qualify.
Angel investors can be friends, family, members of your professional or social networks, individual angel investors or a team of investors. Angel investors often form “angel groups,” in which they evaluate businesses and invest together, pooling resources to make larger investments.
Angel investors typically want ownership in the company they invest in. An angel investor usually provides capital in exchange for equity (stock in the company) or convertible debt, which is a loan that can be converted to equity at a later date.
For example, a company that's valued at $1 million might sell 20% of its equity, worth $200,000, to an angel investor or an angel group.
Generally, angel investors are interested in high-growth, high-potential startups that can earn them several times their original investment. In other words, the potential rewards need to be substantial enough to outweigh the numerous risks of investing in a startup.
Expertise. Angel investors often have industry expertise. They may be entrepreneurs who started a business in your field and can provide advice and coaching to help you succeed.
Connections. Angel investors may have a lot of industry connections. They may be able to introduce you to new customers, financing sources, business partners and other relevant contacts.
Support. Because they’re owners, angel investors typically make money only if the business is successful. This position should motivate them to help add as much value as possible.
Deep pockets. If your small business needs financing later, angel investors might make follow-up investments.
Alternatives. Angel investors might invest even if a business can’t get financing from a bank or a financial institution.
Potential rejection. Even if you think your company offers outstanding growth potential or a game-changing product, angel investors still might reject your pitch. After all, investing in a startup is risky.
Shared control. Some angel investors might demand a large ownership position, and you may end up selling more of the company than you had planned.
Possibly unhelpful. Do due diligence on an angel investor to ensure their interests are aligned with yours. Ask for references and, if possible, talk with other startups that raised money from this investor. You may prefer an angel investor who will be a business partner, help your company grow and contribute to its success, instead of one who's just looking for a return on their investment.
Time and effort. You’ll likely need to prepare a lot of paperwork, such as income statements and projections, balance sheets, cash flow statements and bank statements, so be ready for a potentially lengthy, time-consuming process.
Startups and early-stage businesses that can be scaled for growth are generally the most attractive angel investments. This means your business should be able to increase its sales very quickly over the next few years without a huge increase in fixed costs and expenses.
If you’re willing to give up ownership and potentially control of your company — and think you’d benefit from bringing an experienced investor on board — then angel investors could be a smart move.
You can find potential angel investors in places like these:
The Angel Capital Association, which is the official industry alliance of over 100 of the largest angel investor groups in the United States.
AngelList, which helps match founders with investors.
Gust, which evaluates various funding sources for startups.
MicroVentures, an investment bank offering private market investments.
The Angel Resource Institute, a nonprofit that provides education and information on the best practices in the field of angel investing.
FundingPost brings entrepreneurs together with angel investors through its roundtable events.
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Angel investors are individuals who offer promising startup companies funding in exchange for a piece of the business, usually in the form of equity or royalties. While figures vary on an annual basis, as recently as 2017 angel investors put approximately $25 billion into 70,000 companies.
Angel investors may or may not be accredited investors, a classification given only to investors with very high incomes or net worths. With the passage of 2012’s Jumpstart Our Business Startups Act, the criteria for startup investors was expanded to include more everyday retail investors, including crowdfunding campaigns.
Getting to Know Angel Investors
Angel investors often come from the business world—but that’s not their only point of origin. Angel investors are commonly found in the following professions:
• Business professionals, like lawyers, doctors, accountants and financial advisors, among other professions.
• C-level company executives, who have risen through the ranks and know what it takes to run a successful business.
• Successful small business owners and entrepreneurs who have already launched successful companies and know how to recognize startups that have a bright and profitable future.
• Investors who make financing small businesses a professional pastime.
• Crowdfunding platforms that raise pools of money in groups, with each person investing a small amount in exchange for a small share of any eventual profits, if the company proves successful.
How Angel Investing Works
Angel investors prefer to get involved in the early stage of a company, at the “seed” or “angel” funding phase. That could mean the angel invests when the company exists only as an idea, or it could come when a business is already up and running.
Sometimes angel investors arrive on the scene after the initial round of funding, which normally comes from the founders themselves, friends and family of the founders or from bank financing. Typically, initial business funding isn’t substantial—it’s common for founders to roll out their product or service with $10,000 or so in initial funding.
Angel investors come in after the original funding is in place but typically before a company requires a more sizable investment from a venture capital company. Their investment is needed to grow a company at a critical (and usually early) stage of development, after the initial funding threatens to run out and before venture capital groups show interest in partnering with a promising business.
Here’s how the actual investment process rolls out:
• Angel investors connect with young, developing companies through word of mouth, through business and industry seminars or conventions, through referrals from professional investment organizations, from online business forums or via local events like chamber of commerce meetings.
• If there’s mutual interest, the angel investor will conduct due diligence on the young company by talking to the founders, reviewing business investment documents and gauging the industry the company is targeting.
• Once a verbal agreement between an angel is in place, a term sheet or contract is drawn up, with agreements on the investment terms, payouts or equity percentages, investor rights and protections, governance and control parameters and an eventual exit strategy for the angel investor.
• Once the contract is finalized an actual legal agreement is created and signed, the deal is officially closed and the investment funds are released for the company’s use.
While contribution amounts vary, funding levels can be as low as $5,000 and as high as $150,000. Some angel investors group together as a syndicate and can provide funding up to $1 million for select companies.
Angel investors don’t usually acquire more than a 25% stake in a company. Veteran angel funders know that the company founders need to hold the highest stake in their own companies as they then also have the highest incentive to make their companies successful.
Angel Investors vs Venture Capitalists
While angel investors and venture capital (VC) both fund companies in exchange for a piece of the action, there are significant differences between the two entities. Both tend to invest in startups, but typically they get involved at different stages in a startup’s lifecycle.
“An angel investor is more likely to provide capital for an idea whereas the majority of VCs would like a proof of concept in hand,” says Courtney Lawless, a venture capitalist at Philadelphia-based MoxeHub.
Another difference is the source of funds. Angel investors are private investors that invest their own money. Venture capital funds are run by managers who invest other people’s money, in addition to their own dollars.
Other differences include:
• Smaller funding amounts. As opposed to venture capitalists, who generally write funding checks of $2 million or more, individual angel investors typically write much smaller checks. “Those checks are typically between $10,000 and $100,000,” says Dave Lavinsky, co-founder of Growthink, a business funding provider in Bend, Ore.
• Angel investors are more likely to keep a “hands off” policy on company involvement. Venture capitalists, on the other hand, almost always take a board seat and are involved operationally in a company.
Advantages and Disadvantages of Angel Investing
There are several reasons why emerging startup companies might partner with an angel investor.
Angel Investor Advantages
• No obligations. Because they haven’t applied for a new line of credit and most angel investing involves equity deals, business owners don’t have to pay the angel funder back if the company goes belly up.
• An angel investor is usually an entrepreneur, too. Angel investors often have an abundance of business knowledge and experience. “Especially valuable are financial backers who have established effective organizations on their own,” says Garett Polanco, an accredited angel investor who’s funded 29 companies.
• Less administrative work. Organizations that raise financing from angels are free from onerous investment filings with the U.S. Security and Exchange Commission (SEC) and state regulators that they might have to if they decided to hold, for example, an IPO to raise money.
• More cash down the line. When angels fund a company, they’re often in for the long haul. “They often make another cash injection later on,” says Polanco.
Angel Investor Disadvantages
• Less control. Companies who work with angel partners may need to give up some amount of equity in their business. While that’s normally a small amount, angel financial backers may decide they want a bigger role in business decisions.
• A hit in the pocketbook. Angel investors require compensation for their funding. “That typically comes in the form of equity, which could be more expensive than debt financing,” Lavinsky says.
• Potential for novice investors. A big con of taking on angel investing is winding up with an inexperienced angel investor who offers poor advice or who hounds business owners for status updates. That can especially be the case with new angel funders who steer large amounts of money into a company.
How to Find an Angel Investor
Finding angel investors is a fairly straightforward process.
Start by focusing your search on finding someone close geographically as many angel investors like to play an active role in the business they fund. “We prefer to invest in businesses that are close to home,” Polanco says. “The vast majority of angel investments take place within 50 miles of the angel investor’s home or office.”
Next, target industry associations and digital platforms to locate a good angel investor. You might start with these two angel organizations:
Angel Capital Association (ACA). The ACA is the largest expert advancement association for angels on a global basis, with more than 14,000 private backers and more than 250 angel gatherings and licensed stages. The ACA operates in the U.S., Canada, South America and the Middle East.
Angel Messenger Forum (AMF). New companies looking for equity financing of $100,000 to $1 million can use the AMF to make introductions to pre-screened private and corporate angel backers.
Small businesses seeking angel funding can also use social media to find good angel investment candidates. LinkedIn, in particular, can be a gateway to angel investors—just use the search key to find angels operating in your local area.