An angel investor provides initial seed money for startup businesses, typically in exchange for ownership equity. This might involve a one-time infusion of seed money or an ongoing supply of capital to bring a product to market.
Unlike traditional lenders, angel investors do not offer loans but invest in ideas they find promising, with the expectation of returns only if the business flourishes.
Key Takeaways
- Angel investors can be a primary source of funding for entrepreneurs who prefer them over traditional bank loans.
- This type of investing is inherently risky and generally constitutes no more than 10% of the investor’s portfolio.
- The investor’s involvement can vary from hands-off to deeply involved in the startup’s early stages.
What is an Angel Investor?
Most angel investors are affluent individuals seeking high returns, investing their own money into promising startup ventures. The risks are high, but the rewards can be substantial. On average, angel investments per venture are around $42,000.
Due to the high risks, angel investors typically devote no more than 10% of their portfolios to such investments.
Why Seek an Angel Investor?
Entrepreneurs might prefer angel investors because the terms are often more favorable than conventional financing options. These investors typically seek equity and involve themselves directly in the company, helping to shape its growth trajectory.
Angel investors aim to help startups take foundational steps rather than securing a favorable return on a loan. They often discover startups through online crowdfunding platforms or angel networks.
Origin of Angel Investors
The term “angel investor” originated in the Broadway theatrical world, where wealthy individuals funded productions sometimes contingent on success.
The term was popularized by William Wetzel of the University of New Hampshire’s Center for Venture Research, based on his study of how entrepreneurs gather capital.
Today, Silicon Valley is a prominent hub for angel investors, frequently focusing on internet, software, or AI-based innovations.
Who Can Be an Angel Investor?
Angel investors are individuals with a keen interest in innovation, often having previous entrepreneurial experience. Although many angel investors are accredited due to the nature of their investments, this is not a strict requirement.
Accreditation Insights
Accredited investors, as defined by the SEC, usually have a net worth exceeding $1 million or an annual income above $200,000 for individuals, or $300,000 combined for couples. Accreditation means they can navigate private capital markets with a sound understanding of complex investment proposals.
Sources of Angel Funding
Unlike venture capitalists who pool funds from multiple investors, angel investors typically use their own money. They may utilize structures such as LLCs, trusts, or investment funds for legal or tax purposes.
Investment Profile
Angel investors often seek startup opportunities with clear exit strategies, such as acquisitions or IPOs. The internal rate of return for successful angel investors averages around 22%, underscoring the high-risk, high-reward nature of this investment style.
Ideas that Attract Angel Investors
Though angel investment is often linked with Silicon Valley tech ventures, it spans a diverse range of ideas. Entrepreneurs pitch everything from health products to franchise opportunities, attracting backing from angel investors intrigued by the potential for growth.
Comparing Angel Investors and Venture Capitalists
Venture capitalists manage large sums pooled from numerous investors and typically invest in existing businesses with clear profit potential. In contrast, angel investors allocate personal funds to early-stage ideas, aiming to nurture them into successful enterprises.
Downsides for Entrepreneurs
In exchange for their funding, angel investors often require equity and sometimes control over aspects of the business, like a seat on the board. This can dilute the entrepreneur’s stake and influence.
The Bottom Line
Over recent decades, angel investing has become a vital source of funding for early-stage startups, driving innovation and economic growth. While entrepreneurs gain critical funding and expertise, investors take on significant risk with the potential for substantial rewards, making this a mutually beneficial relationship.
Related Terms: Venture Capitalist, Seed Funding, Angel Network, Crowdfunding, Startup Capital.
References
- Angel Capital Association. “The American Angel”.
- Corporate Finance Institute. “Angel Investor”.
- U.S. Securities & Exchange Commission. “Accredited Investor”.
- Angel Resource Institute. “2016 Angel Returns Study”.
- Ask for Funding. “Recently Funded Companies on Ask for Funding.com”.
