The Ultimate Guide to Angel Investing

Arif Harbott
Arif Harbott

What is angel investing? If you’re thinking of investing, what should you expect?

Over the course of my career, I have built and grown multiple startups. So, when the time was right, it was natural for me to make the leap into angel investing. I learned on the job and, having experienced my fair share of losses, quickly realised angel investing is a path to a fortune if done right, but an expensive hobby if done wrong.

In this article, I’ll be sharing my experiences with angel investing. By drawing on examples, I will explain what angel investing is, how it works, and how you can get started.

Ultimate Guide to Angel Investing

What Is Angel Investing?

Angel investors are high net worth individuals who invest money, and often time, in startup businesses as a means to help them grow.

In return for their investment, they take a small equity position in the startup: meaning they own a certain percentage. They do so with the hope that the company will go on to be successful, and their owned share of the business will significantly grow in value.

High-profile companies like Uber, WhatsApp, and Facebook made angel investors a lot more popular with success stories of early investors making fortunes. And with their steady increase in value, even today, angel investors can earn money from these companies. To give you an example, the image below illustrates some unicorn exits from some high profile venture firms.

Angel Investing and Venture Capital unicorn exits
Unicorn $1bn+ Exits (Source: CBI Insights)

Unfortunately, for most investors, this is the expectation and not the rule – a lot of angels are less fortunate and end up losing money.

What is angel investing? Angel investing is a partnership between the angel and startup company. After the investment, their financial successes become aligned. That is: if the startup is successful, then the angel shares in that success. Equally, if the startup fails then the angel investor loses money.

The majority of angel investors are individuals who have disposable capital and are looking for higher returns than normal stock market investing.

Angels could be:

  • Family and friends: who want to support the startup.
  • Professionals: such as doctors, lawyers, and bankers.
  • Business executives: who are experienced in running large companies.
  • Entrepreneurs: who have run their own startups.
  • Professional angels: who make their living from angel investing.
  • Angel syndicates: this being a group of investors, who work together on deals.
  • Crowdfunders: raising funds from a large group who make a small investment.

How Much Do Angel Investors Typically Invest?

Angel investors invest at the early stages of a company and provide small-scale finance to cover costs during the period where startups might struggle because they’re unattractive to venture capital firms.

This is because, typically, it’s only after utilizing the angel’s investment, and some growth by the startup, that venture capital firms become interested in investing.

The amount that angels invest varies hugely depending on the attractiveness of the startup and their growth needs. But most individual investments are between $5,000 to $150,000.

A typical angel investment round might be $100,000 to $250,000, raised from 3-5 people.

On rare occasions, angel investments could also be as high as $1m. Larger amounts are typically raised through angels investing in groups and syndicates, who pool their finance and their business skills.

Money Raised at the Different Investment Stages
Money Raised at the Different Investment Stages

What do angel investors get for their investment?

The value of a startup that angels typically invest in doesn’t vary much. They usually invest in startups valued between $1m to $4m, and anything valued above that is likely to attract venture capital investments.

Saying that, the valuation of the business doesn’t matter at this stage. Angels don’t make a lot of money because they invested in a $2 million startup over a $1 million one. Rather, they make money when the company they invested in succeeds.

Because of that, when investing, you shouldn’t obsess over deal terms. Instead, you should focus and assess the likelihood of that business growing and being a success.

Angel investors should not be seeking to take control, or majority interest, of the startups they invest in. It’s vital that the founders own a large share so that they are incentivized to grow the business, and consequently, angels usually don’t take more than 20-25% of share ownership.

Typical angel investing ownership structure

What Stage of Companies Do Angel Investors Invest?

Angels usually invest at the early stages of a company. This could be when the business is nothing more than an idea, or when the company is in the early stages of selling their product or service.

At this stage, it’s unusual for the startup to have many customers or much revenue. They might have beta customers, early adopters, or some interest in the market.

Angels are generally the first investors to get involved in a company’s funding after the initial capital raised by the founders. Their money is crucial in the growth of a company during the stage where the capital provided by founders has been spent, but larger institutional VCs (Venture Capital) aren’t interested in investing.

Investment Phases - Angel investing, venture capital and IPO
Business Characteristics by Investment Phases

How Does the Investing Process Work?

There is a tried and tested angel invested process, but it can be expensive in terms of legal costs – and many deals fall apart during this legal negotiation.

Saying that, here are the typical steps of negotiation between a company and angel investor:

  1. Establish deal flow: The first step is becoming aware of potential opportunities and deals. This is best done in a syndicate, but you can generate your own deal flow if you have a strong industry profile.
  1. Screening the deals: Once deals start coming in you’ll need to screen them to find the ones that fit your investment and risk profile. You’re looking for opportunities with low risk, high reward – and at times, this can feel like looking for a needle in a haystack. To do this you’ll need to sit through a lot of pitches, read a lot of investor decks, and do your homework.
  1. Due diligence: For the deals, you like you need to do some deeper research and fact check what the founders are telling you is accurate.
  1. Agree on a term sheet: The next step after you have done your due diligence is to agree a term sheet with the startup. This should outline:
    1. Deal Economics: The proportion of the company the angels will get for their investment. This should also include provisions to ensure that employee options don’t dilute the angels unfairly, as well as liquidation preferences for shares on offer.
    2. Investor Rights / Protection: The most important part of this is an anti-dilution clause. This will prevent the company from diluting investors by selling shares for a lower price than the earlier investor paid.
    3. Governance, Management & Control: Conditions that layout how investors are kept informed of the company performance, how many board seats they have, how critical decisions are made, and how to protect themselves if some of the founders leave.
    4. Exit/Liquidity: Angels want to maximize their chances of getting their money back in exit scenarios. Key clauses that are established are focused on drag-along rights, redemption, and registration rights.
  1. Raise the money: Depending on your situation, this could prove difficult. If you are investing by yourself, it’s a straightforward process, but if you are part of a syndicate then you need to get the backing of other members.
  1. Finalize the legal documents: The term sheet is not the final legal document, but it does guide the final legal agreement. Many parts of a term sheet are open to interpretation, so the legal document goes into a lot more detail and is typically a lot longer in length.
  1. Closing the deal: The final step is for a closing date and process to be defined. The legal documents are sent for signatures and funds are then released. When the closing process has been completed the deal is legally binding.

Finally, once you have made your initial investment, you could opt to invest in follow-on investment rounds, to keep a good shareholding in later rounds if the company grows and does financially well.

The steps in an angel investing deal

What Does an Angel Do in Their Startup Company?

There are no hard and fast rules about how an angel investor works with the companies they have invested in.

Saying that, it is in the investor’s interest to make their investment succeed. Therefore, they tend not to just put their feet up after writing a check. Instead, they usually work with the startup during its early stages.

If you’re considering becoming an angel investor, make sure you and the startup agree in advance how much time you will spend working with them and what you will do for them.

The main roles that angels play include:

Source of Capital: You invest some money and do nothing else. This is not advisable – but it does happen.

Advisor: Working ad hoc with the founding team, providing business advice, stress testing products, and propositions or being a shoulder to cry on.  In short, you provide an external point of view and a fresh pair of eyes.

Networker: If you have connections in the areas your startup needs then you could leverage your network to get customers. Many professional investors are very well connected and know a lot of profiles in their area.

Recruiter: Startups often need to scale up and grow quickly. With that, hiring can be a serious block to progression. Investors often refer people who they have worked with in the past to shortcut the hiring process.

PR and Marketing Buzz: Many startups have great products but very few know how to market and sell them. Some angels use their personal platform to create some buzz, as this is a very cost-effective way to gain early interest.

Technical Expert: If you have relevant experience, then you could provide assurance, advice, or expertise into the startup’s product development.

Board Member: The board is responsible for making the critical company decisions, such as whether to raise capital, whether to be acquired, and whether to hire or fire senior management. So, who is on the board is a big responsibility and can make a huge difference to the company.

Types of Angel Investor Roles

What Are the Benefits of Angel Investing?

From what I have heard from angel investors, and from my personal experience, there are numerous benefits of becoming an angel.

To name a few of these advantages:

  • Asset diversification: Angel investing allows you to diversify into a high-risk, high-reward asset class.
  • Professional variety: It’s very intellectually stimulating working with a variety of startups, as it gives you a variety from my day job and allows you to develop new skills.
  • Entrepreneurial community: By working with startups and founders you can tap into a whole ecosystem of support and camaraderie that isn’t usually available in the corporate world.
  • Networking opportunities: You can access a whole network of other founders, investors, partners, lawyers, and a huge tech community.
  • Monetizing your expertise: Your founders may ask for your help and advice (if you have relevant skills) and this could lead to more angel deals or potentially paid work.
  • Startup education: You gain an insight into the joy and pain of running a startup. In short, you’ll gain lessons and education that money can’t buy.
  • See the latest trends: Startups allow you to stay up to date on the latest trends and technologies. They give you a reason to research and learn about new markets and new businesses which keeps your mind active.
  • Huge potential returns. If you manage to hit a home run and back a winner, there is a huge financial upside. You could double down and then get a great exit.

What Are the Downsides of Angel Investing?

Despite all the advantages I mentioned, there are a few downsides and risks involved with this type of investing:

  • You could lose a lot of money: Most of your investments will fail, and if that happens – your value in a company could become worthless overnight. That is why you should only invest a small portion of your wealth into angel investing.
  • Return periods can be very long: As we have mentioned before there is very little liquidity in angel investing so it can take many years before you actually get cash in the bank from your investment winners. This is a long game, not a get rich quick scheme.
  • It is a journey into the unknown: Your decision is more judgment than deep analysis and evidence. At the angel investment stage, the level of information and certainty you have is very low, so this is not for people that do not like the unknown.

For me, the upsides far outstrip the downsides, the enjoyment I get from working with founders, solving the inevitable problems that arise growing the business, and then seeing new companies flourish is a huge professional thrill.

Can You Make Money in Angel Investing?

There is a 0.00067% chance that the business you invest in will go on to be worth $1 Billion. Couple that with the fact 90% of startups fail and investing does not look like a recipe for making money.

The biggest risk involved stems from the fact that if an investment fails, you lose all of your invested money, rather than just some of it.

Even those investments that do not outright fail could go into a zombie state (that being a company that requires continuous bailouts to operate.) These zombie investments never achieve real scale and therefore there is never an opportunity to make any money from them.

“Assume you’ll lose everything in angel investing. Because you probably will’

Itai Damti

Now for the small amount of good news, for those that are lucky enough to pick a winner, these could make up for all of your failed investments.

To name a few promising examples – early investors in Google received over a 1000x return on their investment, while eBay’s early investors received a whopping 1500x return. These extreme examples illustrate the promise and potential of angel investing. Even a very small investment could yield big returns if your investment goes on to be very successful.

Let’s talk through an example.

Imagine you invest $20k in an early-stage startup at a valuation of $2m. You’ve picked a great founding team that executes successfully and is wildly successful.

Suppose you avoided your share becoming diluted by VC investments, and the company went on to be sold for $40m. Here, your investment would be worth $250,000. That’s a 10X return on your initial $20k!

There are lots of caveats in this example, but it is possible to make a good return if you are lucky enough to find a winner.

Remember that you only receive your gains in cash when there is a liquidity event. Which is the name for an opportunity for shareholders to turn their shares and assets that are tied up, into cold, hard cash.

There are a variety of different types of liquidity events. The two main ones being:

  1. Initial Public Offering (IPO): After an IPO, the company’s shares become available for the public to buy and trade. It’s here that the company’s founders and shareholders may sell their shares and monetise their initial investments.
  2. Direct Acquisition: An alternative way to monetise investments is to sell the company or sell your stake in the company to an interested party, rather than going public. Examples might include: an acquisition or merger when a shareholder sells their stake of the company to another business.
Angel Investment Payback Returns

How Is It Different From Investing in the Stock Market?

Angel investment is radically different from investing in public markets.

Here are some of the way’s the two differ:

  • Timescales: Stock market investors could theoretically see a return within a few days, they could also increase or decrease their holdings in minutes. By comparison, in angel investing your capital is locked in for as long as 7-10 years.
  • Deal Flow: It is very easy to invest in the stock market. All you need is a brokerage account and you can start trading. With angel investing, a deal flow is much harder to source.
  • Research: There is a huge amount of information, analysis, and news on public companies who must report their finances regularly. For startups, there is almost no available information available about the company.
  • Influence: When you buy stock in a public company you have no influence and say over how the company is run and managed. However, with angel investments, there is plenty of scope to influence the strategy of the startup.
  • Returns: Stock market returns average 10-15% per year, due to their relatively low risk. Angel investing is a much higher risk so the returns can be much higher for the companies that end up being successful.
New York Stock Exchange (Source: REUTERS/Lucas Jackson)

What’s the Difference Between Angels and Venture Capitalists?

To some extent, angel and VC investors are very similar. They both make investments into early-stage, high potential companies hoping that a small number of successful companies will make the majority of their returns.

The big difference is that angels invest their own money and VCs are investing other people’s money. 

Angels tend to be individuals investing a portion of their net wealth in working with startups. VCs tend to be professional money managers who are investing money from a fund they raised from limited partners.

This means VCs have much higher amounts of capital to deploy, their funds can run into tens of millions, with some of the big funds being in the billions of dollars.

With large amounts of capital to deploy VCs favour larger-scale opportunities which typically means they are investing in later-stage companies to angels.

How Can You Get Started as a New Angel Investor?

Here is a seven-step process to becoming an angel investor:

Step 1: Self accredit your financial status
To be an angel investor you usually have to be accredited, which means you need to self-declare that you meet the guidelines in your country:

  • U.S. an ‘accredited investor’ is someone with $1M in assets or income >$200k
  • UK high net worth certification is an annual income of at least $100,000, or net assets of £250,000 or more

Step 2: Decide on your asset allocation for angel investing
A good guideline is not to put more than 10-15% of your net worth into this regardless of how good the deal flow is. An even better way is to spread this 10% out over five years, rather than investing it all in year 1.

Step 3: Mentally write off the money you have just allocated
Most people do not make money in angel investing so you’ll likely to lose most, if not all of the money you have just allocated.

Step 4: Learn about angel investing
Meet at least 5-10 experienced angel investors (many angel investors have limited experience of actually doing deals). Try and learn as much as you can from them and listen to their pearls of wisdom.

Step 5: Find some deal flow
The best way to do this is to join a syndicate. Find syndicates that you like the look of and piggyback off the “lead investor”. They will handle all of the terms, legality and paperwork for you.

Step 6: Make 5-10 investments in “winners”
Invest $5k in 5-10 companies to get experience and see how angel investing works. Making a number of investments are important as insiders will be reluctant to work with you until you have proven yourself.

Step 7: Generate your own deal flow
Once you have made your initial investments you can, if you like, start creating your own deal flow instead of going through a syndicate. The best founders already have an inner circle of angels so you’ll only see deals that others have passed on unless you create your own deal flow.

That’s all it takes to be an angel investor.

Summary

This article has given you insight into what angel investing is, how it differs from venture capitals, and what you should expect if you were to become one.

To summarise the key points:

  • Angel investor are high net-worth individuals who invest in startups at the early stages of the business.
  • Angel investors typically invest between $5,000 – $150,000. And for that, they own a share of the company.
  • If the company becomes successful, that investor will yield a high return on their investment. If not then the angel investor is likely to lose all of their investment.
  • Although some angel investors have little involvement in a startup, a lot have a hands-on approach with the investment company.
  • Compared to Venture Capitals and stock market investing, angel investing is significantly higher risk.
  • Investors must wait for a liquidity event to capitalise and turn their share into cash.
  • Finally, we rounded off by illustrating the steps you could take to become an angel investor.
The Ultimate Guide to Angel Investing
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