An angel investor is a person who invests in a new or small business venture, providing capital for start-up or expansion. Angel investors are typically individuals who have spare cash available and are looking for a higher rate of return than would be given by more traditional investments. An angel investor typically looks for a return of 25 percent or more.

Angel investment is a form of equity financing–the investor supplies funding in exchange for taking an equity position in the company. Equity financing is normally used by non-established businesses that do not have sufficient cash flow or collateral with which to secure business loans from financial institutions.

Angel investors fill in the gap between the small-scale financing provided by family and friends and venture capitalists. Attracting Angel Investors is not always easy, but there are things you can do. First, consider whether angel investing is truly for you and your business.

• What Percentage Should an Angel Investor get?
• What are the Pros and Cons of angel investors?
• How does Angel Investment Network work?
• 5 Things you Should Know about Angel Investors
• How do I Become an Angel Investor with Little Money?
• What to Look for in a Worthy Investment
• How to Spot a Bad Investment

What Percentage Should an Angel Investor get?

Getting your business off the ground or taking it to the next level usually means securing funds from a small business investor. This provides an attractive way to get working capital in exchange for a stake in the business.

Before you make a presentation to an investor, be clear about the amount of money you need and how much of your company you’re willing to give in exchange.

Read Also: Investing With Intelligence: 7 Tips for Tracking Performance of Your Investment

While it may be possible to buy back some of the shares that you have issued to an angel investor, in general terms, once the shares are gone, they are gone. The investor is with you until you sell your business.

Most investors take a percentage of ownership in your company in exchange for providing capital. Angel investors typically want from 20 to 25 percent return on the money they invest in your company. Venture capitalists may take even more; if the product is still in development, for example, an investor may want 40 percent of the business to compensate for the high risk it is taking.

Invariably, an investor will ask for equity in your company so they’re with you until you sell the business. You may not like giving away a cut of your company. But remember, the money is not a loan. You asking the investor to put up money they may not get back.

You may feel tempted to take the first business investment offer you receive. Remember, however, that you need to work with this person for the duration of your business. Before you jump, look for investors who have experience in your industry and who get involved with companies at certain stages.

What are the Pros and Cons of angel investors?

Pros

1. Angel investors are the most likely to take on the risk of your opportunity.
It can be very difficult to qualify for a small business loan. You might not be in a position to issue shares in order to raise capital. Every opportunity that comes your way may come with an answer of “No” associated with it because of the risk involved. Angel investors are willing to take on that risk because they’re looking more at the future potential than the current valuation as long as you’re willing to give them an ownership stake in the business – often 10% or more.

2. An investment from angels is not debt.
You’re not going to be forced to pay back funds with interest when you receive an investment. What you will need to do is provide an angel investor with an ownership stake in your business. The goal of the investment is for both of you to be able to find financial security through this business venture. If your idea doesn’t work out, you’re not stuck with debt hovering over your head. You’re also not stuck with the monthly payments that can cut into your general revenues quite severely in the early days of your business.

3. Angel investors give your business a better chance to find success.
Most angel investors are going to be actively involved with your business. You’ll be able to take advantage of their experience in your industry to begin building a solid brand. Angels help businesses stay active longer, experience larger levels of growth, and achieve a better rate of return than business who don’t have angels involved. In many ways, an angel investor becomes a mentor that is willing to pay you to be involved.

4. Angels often perform their due diligence very rapidly.
Unlike other types of capital or debt that you might access, the due diligence process for an angel investor is usually quite rapid. Many angels can complete this process in 30 days or less. The reason for this is pretty simple: most angels will only invest into businesses that are run by people they trust. You’ll find angels could be your next door neighbor, a friend of a friend, or within your professional network already.

5. You gain a link to their network and community.
Building relationships will always be at the core of a successful business. When an angel comes on-board, you gain access to their network immediately. You’ve become part of their community. This allows you to build relationships in ways that would take you years to do on your own. In return, your brand can expand exponentially and help both you and your angel profit from it.

6. Angels are literally everywhere.
Every industry today has angel investors that are just waiting for what they feel is the perfect opportunity. They invest in all markets around the world as well, which means every business has the chance to find the partnership that they need. Many communities even have groups of angels that meet regularly to explore local and regional opportunities that may be available. You don’t have to look very hard to find an angel investor if you’re serious about it.

7. Angel investments can happen at any stage of the business evolution cycle.
If you’re a start-up business, then an angel investor might be willing to put down $25k to help you build your identity. If you have a late-stage venture that is on the brink of success, you might find an investment of $1 million or more headed your way. Because of the flexibility of this type of agreement, angels are often ready to negotiate with you so that both parties can get the best deal possible.

8. You get a chance to give back.
Many angels take pride in their ability to give back to their community. You get to hitch along for this ride, helping people you might never get to help. Don’t underestimate the power of what this can do for your business.

Cons

1. A high tolerance for risk has its price.
Angel investors get involved with businesses because they expect to see a return on their investment. They are going to set the bar high for your success. If they make a large investment, then they’re going to expect your business to perform. Most angels will give you 5-7 years to hand out a return and they will put pressure on you every moment of every day to make that happen. That stress can cause some entrepreneurs to fold the first time they experience it because it can be so unexpectedly overwhelming.

2. You’re limiting your future profits with an angel investor.
Because you’re selling an equity stake in your business in return for an investment, you are giving away a portion of your future earnings based on the ownership stake you agree in exchange for the money today. If you give an angel investor a 33% stake in your business, then $1 out of every $3 you make is going to the pocket of the angel investor. That doesn’t seem like a lot until you start thinking in larger monetary terms.

3. You lose some control over your business.
If you pay for something, you expect to have some control over the experience you receive. That’s why when we receive poor customer service at a restaurant or a retail establishment, we feel dissatisfied. Angels feel the same way when they’re investing money into your business. Most angels want an active role in the decision-making process. Many business owners go into this relationship thinking that their investors will take a hands-off approach and find it to be a very different experience. Even if you do have a hands-off angel, you’ll be accountable for the decisions you make – especially if they cost the angel money.

4. Angels come in expecting a way to exit.
Most angel investors aren’t going to stick around for life. They get into a business opportunity to receive a return. Their goal is to find a way to achieve an exit after they’ve received the return that they want. If you’re making huge profits, then of course an angel might stick around for a while. You must be prepared that when you receive this investment, an angel has already plotted the best way to get out.

5. Don’t expect to receive follow-up investments.
Angel investors are typically going to make one investment only. They don’t want to be seen as a bank that allows you to withdraw funds whenever you feel it may be necessary. Angels want you to make your business work for you and for them. Even though they’re willing to take on more risks than others, they’re not going to keep investing in high-risk scenarios.

6. Not every angel investor has a mutual best interest at heart.
Some angel investors can be deceptive about their intentions with your business. They are impatient, are focused on a fast cash grab, and won’t provide any guidance or mentoring as you attempt to build your business. It’s up to you as the entrepreneur to perform your own due diligence on the angels with whom you’re interested in partnering just as they are performing their own due diligence with you.

7. Angel investors do not have the same level of national recognition.
You’re not going to find a database of angel investors that are available right now to hear your business pitch. You must go out and find them on your own. Many angels stay in the shadows just because they don’t want to be pestered with hundreds of phone calls per week from entrepreneurs that want them to get involved with their latest idea.

8. Some angels invest into companies that are outside their expertise.
Everyone wants to have a diversified portfolio in order to protect their best interests. Angels are no different. They will often look at industries outside of their regular experience to help diversify their finances. When an angel with limited knowledge comes into your arena, it can put you at a disadvantage even though you’ve got the investment you wanted.

The pros and cons of angel investors show that with the right partnership, great things can happen for any business. Whether it’s a start-up or an established business trying to market an innovative idea, angels can be the difference between success and failure. Avoid the disadvantages with proactive planning and you’ll be taking the first steps forward on your journey toward financial stability.

How does Angel Investment Network work?

As described in my book, The Art of Startup Fundraising, high net worth individuals make up the bulk of the ranks of start-up investors. These individuals are often referred to as ‘Angel Investors’ or ‘Accredited Investors’. The term angel investor actually was born out of investors that financed the broadway shows back in the day.

While an angel is normally an accredited investor, this isn’t always true. And not all accredited investors are angels. Together, these individuals both have the finances and desire to provide funding and for many reasons, they are among the most appealing sources of funding for start-up founders.

While there are various levels and definitions of ‘high net worth’ individuals; accredited investors are defined as those with a net worth of $1M in assets or more (excluding personal residences), or they have $200k in income for the previous 2 years, or a combined income of $300k for married couples. This is all according to the definition established by the Securities and Exchange Commission (SEC).

Angel investors are individuals who invest in start-up businesses; normally in the early stages. This tends to be on Seed rounds of financing and also Series A rounds. Super Angels are those that invest checks north of $500K on Series A and up.

Angel investors also invest via family offices if they are ultra high net worth individuals. Family offices often go unnoticed or unrecognized by many entrepreneurs and start-ups. But they are a very significant force in the investment world and capital markets. So much so that they effectively lobbied Congress to provide family offices exemption under the Dodd-Frank Act. We’re talking about Rockefeller money.

Angel investors fill the gap between friends and family, and more formal venture capital funds. Some invest purely for profit. Others look to make an impact with their funds by investing in causes and industries they are really passionate about. This can range from sustainable farming to education and healthcare start-ups.

Angel investors invest their own money, where the typical amount raised ranges from $150,000 to $2,000,000. According to Richard Branson’s VirginStartups.org angels invest around $1B in startups in the UK each year.

Since angel investors are very often individuals that have held executive positions at large corporations, they can often provide fantastic advice and introductions to the entrepreneur, in addition to the funds. A Harvard report provided information on how angel funded start-ups had a higher chance of survival.

Angel investments are high-risk, which is why this strategy normally doesn’t represent over 10% of the investment portfolio of any given individual. What angel investors look for is a great team with a good market that could potentially return 10 times their initial investment in a period of 5 years. The exits, or liquidity events, are for the most part via an initial public offering or an acquisition.

According to the Halo Report, angel investors particularly like start-ups operating in the following industries: internet (37.4%), healthcare (23.5%), mobile and telecom (10.4%), energy and utilities (4.3%), electronics (4.3%), consumer products and services (3.5%), and other industries (16.5%).

Data collected by the Kauffman Foundation shows that the best estimate for angel investor returns is 2.5 times their investment even though the odds of a positive return are less than 50%, which is absolutely competitive with venture capital returns.

Reaching nearly $23 billion, angel investors are not only responsible for funding over 67,000 start-up ventures annually, but their capital also contributed to job growth by helping to finance 274,800 new jobs, according to the Angel Market Analysis by the Center for Venture Research at the University of New Hampshire. On the contrary, venture capital firms only invest in 1,000 new companies per year.

While angel investors contribute about five times less capital to start-ups than VCs, individual investments in start-ups grew by 36 percent from 2008-2012, while venture capital investments dropped by 8%, according to Dow Jones VentureSource. 

Thanks to the JOBS Act, need for new investments following the 2008 financial crisis, increasing awareness and new technology there were over 750,000 active angel investors by 2013 when the new regulations were starting to be implemented.

The dominating geographic area, in terms of number of angel investments, is Silicon Valley, however, Silicon Alley (New York City) is catching up quickly.

Six reasons these high net worth investors are an attractive source of capital for you:

1. They can lend additional value via advice from experience
2. Ability to raise more money through fewer investors and contacts
3. Fewer restrictions on raising money from accredited investors
4. They may put in more money later on
5. ‘Birds of a feather flock together’ – meaning potential referrals to other angels
6. Flexibility in terms

Note that a Stanford study reports that 90% of all seed and start-up capital comes from angel investors.

Once you know who to pitch, it’s all about perfecting the pitch deck to close your round of funding. For a winning deck, take a look at the pitch deck template created by Silicon Valley legend, Peter Thiel that I recently covered.

Thiel was actually the first angel investor in Facebook with a $500K check that turned into more than $1 billion in cash.

5 Things you Should Know about Angel Investors

1. They don’t make money–but like to make a difference

Perhaps the most surprising thing you can learn about angels is that they typically don’t make money from their investments. As Cohen says:

Even the smartest angels I know feel lucky if they are net-zero after a few years. The reality is that most start-ups fail, and despite what angels may believe about their ability to distinguish the winners from the losers, most angels, including me, aren’t that smart.

Cohen isn’t the only one who says the risk of early-stage investment is high. Fred Wilson of VC firm Union Square Ventures says that one-third of early-stage investments are hit, meaning they return five times the investment or more. The other two-thirds either make a little money or, in half the outcomes, either “slog it out” for years or run out of cash and cannot support themselves.

The lesson is that angels are optimistic and often disappointed. The less experienced the angel, the greater the chance of disappointment and even bitterness. When you talk to angels, be clear on the risks and make sure they understand all the obstacles. It’s the only fair way to proceed, and the reputation you build today will follow you in future endeavors.

Also, angels are in the game for something other than money. Maybe it’s a chance to give back, help shape the future or even see the future from close up. When you work with angels, you need to understand that they may be looking for something other than straight financial return, so know when you might be able to help them satisfy their itch.

2. The angel sweet spot is $150,000 to $1.5 million

David S. Rose, founder of the New York Angels, broke out where entrepreneurs typically look for given amounts of money:

• Up to $25,000, the choice is usually self-funding. If you don’t have that much money in, many others will be uneasy about taking part.
• From $25,000 to $150,000, you’re looking at friends and family, offering either common stock or convertible notes.
• The angel sweet spot is between $150,000 and $1.5 million, more often raised from a number of individuals but sometimes from a single generous and well-off person. Why particularly well-off? Go back to how often these investments fall flat.
• In the $1.5 million to $10 million range, you’re in early-stage venture capital in at least two phases, with half of the money up front and the rest paid in phases. More than this, and it’s a late-stage venture fund.

In other words, working with angels may make sense at a particular early stage of business growth. Going to them too early or too late will minimize your chances of getting interest.

3. There are unscrupulous angels. Avoid them at all costs

Some angels are focused only on what they can get out of you. As Cohen writes, “Investors who ask you for a job are thinking only of themselves.” There are brokers who want fees for introducing you to investors. Some angels use their position as investors to try and prove how much smarter they are than you could ever be, criticizing every decision you make. Avoid all these types. Starting a business is tough enough as it is.

4. Show, don’t tell.

Angels expect you to have done some due diligence and research when it comes to them–at least finding basic information about their background, why they invest, what they’re looking for, their previous investments, and value they can add beyond cash.

Many angels have websites and some blog. You want to demonstrate to an angel that you put time, thought, and energy into your activities. Here’s Cohen on being pitched by someone who hasn’t looked for information on him:

Let me be blunt here. If founders haven’t done this basic homework before calling me, I have to believe they will be just as lazy when it comes to calling prospects or customers.

This is a perfect example of what you need to do in marketing and many forms of communication: show, don’t tell. If you talk about your ability in sales and marketing but don’t take the basic steps in approaching the angel investor, you’re indicating that you might be more talk than action.

5. It’s always personal.

VCs run funds usually filled with other people’s money. Angels write checks out of their own accounts. They want to connect with entrepreneurs and their businesses, but also with people. Be authentic, not some PR story you’ve already concocted.

How do I Become an Angel Investor with Little Money?

If you’re going to get into angel investing, you should have the funds to do it. Most experts recommend allocating up to 10% of your portfolio to angel investments. But this still doesn’t really answer the question of how much money you need to become an angel investor.

The easy (though probably not great) answer is that it depends on the type and size of investments you’re looking to make. Using Shark Tank as an example again, those investments can be hundreds of thousands of dollars – but the investors have it and the businesses need it.

You can invest on a much smaller scale–more like tens of thousands of dollars–depending on what the business needs. Note, though, that the smaller your investment, the smaller your share (and, in turn, profits) will be. It will also limit your ability to make decisions, which at that point it becomes just more of an investment – not what I’d consider an angel investment.

If your overall investment portfolio is $100,000, that would meet the 10% mark. But to invest in good startup businesses, you would be ready with at least $50,000–meaning your overall portfolio should be close to $500,000.

But the problem is, these may not be true angel investments, or you may be investing in a small business that has more risk.

In many cases, you’ll need to be an accredited investor, which means that you have an annual income of at least $200,000 or a net worth of at least $1 million. The reason this is important is that businesses that get investments from accredited investors aren’t required to file a lot of the securities filings with the SEC and state securities regulators. Because of this, most businesses looking for angel investments want accredited investors.

Is It a Safe Investment Option?

Not exactly. There’s inherent risk when you become an angel investor. In fact, data shows that at least 50% of angel investments lose some, if not all, of their money. On the flip side (and also outlined in that data), angel investments can produce an extraordinary return.

If you have $1 million in your portfolio, that gives you $100,000 to comfortably play around with. As an angel investment, you could lose all of that, but you could also hit an incredible return. So my advice is to look at it like gambling – in that you should never invest what you’re not willing to completely lose.

Remember, angel investments are much different than investing in a stock. With stocks, you have historical returns, financials, you can assess the competence of the leadership team, you have analyst opinions, and a whole slew of other information at your fingertips (if you know what you’re doing).

With angel investing, you do have some of that, but it’s a lot harder to come by. In many cases, you’ll get to see and understand the business, meet the owners, and see the financials. But what’s unpredictable is how it’ll turn out after you invest and start making decisions or changes.

What to Look for in a Worthy Investment

You absolutely have to have a copy of all the business’ financials, if it’s an established company. Look at it like you’d look at a stock – reviewing their revenues, costs, and bottom-line margins. Are their revenues declining? Are costs increasing? Where are they “fat” – meaning, do they have too much overhead (i.e., too many people)? What would happen if you reduced staff or shut off pieces of the business that weren’t profitable?

Those are the types of questions you need to ask. You need to think like an investor, but also the CEO of a company–every move you make could have a profound impact on the business and its ability to generate revenues (or even survive).

We would recommend looking at a business that has increased revenues over the past several quarters and years, while keeping the cost of sales and operations relatively flat (if not slightly increasing within reason), and margins above average for the industry. This will vary widely based on the industry, but a big margin allows you some room to make mistakes without losing the business.

We would also gravitate toward a business that had a lot of cash on hand and little to no debt. This is important since cash will help the business weather any storms without sinking their business into more debt.

Finally, get to know the business and the people running it. Is the business a good idea? Does it have long-term prospects? Can you grow it? Are there areas of opportunity that you can capitalize on? Ask those questions about the business to yourself, the owners, workers, and even customers.

Knowing the people who run the business is also critical. You want to work with someone who is open-minded and realistic about things changing. You want to make sure you have a say, and that say is put into action. Some business owners are too proud and controlling to let anyone tell them what to do–and I would stay away from those businesses.

How to Spot a Bad Investment

A bad investment is pretty much the inverse of what I described above. Owners who are controlling and don’t want to change (or say they will but are resistant). Financials that don’t look great. Debt on the books. A business idea that’s just terrible and has no growth potential.

Also important is a business you know something about. A bad investment would be in a business you know nothing about and have no interest in. If you’re investing in portable toilets, for example, it may be a profitable business – but do you want to be part owner of that business? How much do you know about portable toilets? Are you willing to stick with it for 7-10 years if you have to?

Read Also: How to Invest in Startups without being wealthy for as low as $100

Now, there are exceptions – you can find some diamonds in the rough. This takes YEARS of experience, though. It’s like finding an undervalued stock. Finding an undervalued business means that it’s in terrible shape today, but with an influx in cash and some good management, it could be turned around.

Finally

Angel investing has grown over the past few decades as the lure of profitability has allowed it to become a primary source of funding for many startups. This, in turn, has fostered innovation which translates into economic growth.

Angel investors can make a lot of money if they know what they’re doing. But angel investing can be risky, so it’s easy to lose a substantial amount of money as well. If you want to become an angel investor yourself, do your homework on the company you want to invest in and sign a contract before you hand over any funds.

Potential startups that are worth the risk have knowledgeable leadership and thorough business plans as well as convincing pitches. Vet the startup’s leaders as thoroughly as you would for any other significant new relationship, and your investments can pay off big time.