The Angel Capital Association presents this short overview on angel investing as part of its ongoing member education program. 

What is angel investing?

Angel investors (also known as seed investors) provide financial capital for early stage startup companies, in exchange for ownership equity. Angels typically use their own money and invest directly in individual companies, unlike venture capitalists who raise and strategically manage funds of pooled money from many individuals and institutions who themselves are not selecting the companies in which to invest. Angel investors are often the first people to invest in a company outside of the founder’s family and friends, and are often interested in providing guidance and support to companies, not just funding. The support that angel investors provide fosters innovation, connects entrepreneurs to potential customers and partners by tapping into established local and regional networks, and facilitates growth of the entire startup ecosystem.

Angel investing is risky but when a startup does thrive, angels can walk away with significant returns. It is important for angel investors to take a portfolio approach to investing and plan to make at minimum ten investments in order to make a return, counting on one or two to provide the majority of the return. Examples of highly successful angel-backed businesses include Google, Yahoo, Amazon, Starbucks, Facebook, Costco and PayPal.

Entrepreneurs typically raise angel investments in reliance on Rule 506 of “Regulation D,” a US federal securities offering exemption that involves a filing with the SEC and notice filings with appropriate states, and their startups usually go through several rounds of funding with multiple investors. The investment process and access to angel financing is made much easier by the rise of angel groups, which exist to help individual angels evaluate and invest in entrepreneurial ventures. The angels meet regularly to review business proposals, meet with entrepreneurs, conduct due diligence, and potentially pool (still their own, personal) capital to make larger investments. ACA is the largest angel investor professional development organization in the world, with 250+ active angel groups and 14,000 individual angels.

Who can be an angel investor, and who should consider this method of investment?

ACA recommends that entrepreneurs work with accredited investors who can also add non-financial value to the company, via their market knowledge, leadership advice, and mentoring. The Securities and Exchange Commission (SEC) defines an "accredited investor" as one with a net worth of $1M in assets or more (excluding the person’s primary residence), or having earned $200k in income for the previous 2 years ($300k for married couples), with a reasonable expectation of reaching the same income threshold in the current year.

The best angel investors are often successful entrepreneurs themselves, or they’re well-versed in a market segment and want to have more involvement with early-stage companies. Angels are often passionate about “paying it forward” and supporting the next generation of startups. They are interested in returns on investments, of course, but they also want to leave a legacy and pass their experience and knowledge on, driving growth in their communities and industries.

Experts recommend allocating 10% or less of your total investments to build your of angel investment portfolio because of the risky nature of early stage investing. Investors should also remember that it takes several years for a startup to become profitable and potentially even longer for an “exit.” An exit can be a sale of the company or its business, or an IPO, or any other means by which a company achieves liquidity for its investors.

What value does angel investing offer to the startup ecosystem?

Small businesses led by individuals or families are important to local economies, foster innovation across sectors, and boost job growth. Angel investments are ideal for businesses that are established enough to have a strong concept and plan, but young enough to need capital to move to the next stage of development. Angel financing offers better terms than other sources and doesn’t add debt to an entrepreneur’s balance sheet. In addition to financial capital, angels often mentor and coach their portfolio companies, to encourage healthy growth. They introduce entrepreneurs to potential customers and investors, help solve market challenges, and enable start-up firms to gain credibility in their fields.

Academic research1 found that startups with angel funding have a 70% greater likelihood of obtaining more financing in the future, and angel-backed companies hire more employees and develop more innovation than their non-angel-funded counterparts.  

[1] William R. Kerr, Josh Lerner, and Antoinette Schoar. "The Consequences of Entrepreneurial Finance: Evidence from Angel Financings," Review of Financial Studies 27, no. 1, 2014. 

What do angel investors look for in a startup company and how are investments made?

According to ACA, angels will aggressively strive to invest their capital in innovative companies that will disrupt their category and have the potential to grow to market leadership and be targets for acquisition within three to seven years of startup. Such companies command the highest level of interest from angels and the associated demand often results in short windows of opportunity when a funding round opens.

While investors employ a number of decision-making strategies around deal selections, there are commonalities around smart practices to evaluate potential investments. For angels working a deal as part of a group, the following example includes these practices: 

  • Funding evaluations start with an application and pre-screening process, where business plans and high-level financials (including budgets and projections) are reviewed. If an application is accepted, a small subset of individual angels from the group will typically do a deeper review of the startup, meet the entrepreneur, and create a due diligence committee to work through a full understanding of the business plan and funding model.
  • If the committee feels the larger group would be interested in the opportunity, the entrepreneur is invited to make a pitch at one of their meetings, allowing all members to ask questions and discuss key issues about the company’s strategies and value proposition. If enough interest is present, a full due diligence check is initiated and the group will review a company’s full business plan, evaluate market opportunities, interview the management team, and, if the group is still interested at this point, they’ll begin negotiating a term sheet to place a value on the investment and/or set terms around a note-based investment.

Due diligence is an important piece of the company selection process and many investors join angel groups to share this load across many companies. Regardless if an angel investor is acting independently, part of an angel group, or investing through a marketplace platform, ACA member investors are constantly refining their processes and learning smart practices from others within the network, leveraging successes around the world to drive better results. A collection of these smart practices and lessons learned is presented during ACA’s annual event – ACA 2020 - The Summit of Angel Investing, and the organization’s all-new ACA Angel University, which features tracks and sessions on each stage of the investment process.

How can a new angel, or someone considering angel investing, learn more?

Experts recommend growing your network of successful angel investors to establish connections, get access to deals, work together to conduct due diligence, and learn from experienced angels. 

Because, at the end of the day, each angel investor is investing her own money and making her own investment decision, deal by deal, it’s important to leverage professional networks and best practices to optimize the prospects for success.

Events and workshops can be a fast track to understanding the fundamentals of angel investing, building relationships with experienced investors, and expanding your access to the flow of potential deals. Plus, many events offer opportunities to meet promising entrepreneurs, watch pitches from startup companies (many of which are often actively raising capital), and understand the questions investors ask before making a deal. ACA offers a unique combination of an event and a training course, in one location, to make it easy for those considering angel investing to get a comprehensive overview:

Interested in learning more about angel investing?

Download the 2019 Angel Funders Report

Get the insider’s view of real-world angel investments, including investment amounts and returns, how many angels invested in each deal, experience levels of startup CEOs, and much more. The Angel Funders Report includes data and insights from 1,170 investments in 68 different angel groups – and it’s a powerful tool for considering your future portfolio.