What are Angel Investors?
Angel investors refer to wealthy investors who supply capital to budding businesses in return for a portion of their equity. Reference to the word angel implies a certain comfort as these investments help startups with early-stage financing to find a footing in the market. The business does not owe any debts to the fund supplier.
However, the investor scores a heavy profit as a shareholderShareholderA shareholder is an individual or an institution that owns one or more shares of stock in a public or a private corporation and, therefore, are the legal owners of the company. The ownership percentage depends on the number of shares they hold against the company's total shares.read more when the startup finally undergoes public listing or an acquisition.
Key Takeaways
- Angel investors are usually high-net-worth individuals who provide capital to potential early-stage business entities in return for a certain percentage of company shares.
- They take an enormous risk since the business they fund holds no records or assurance of success. In addition, the investor often provide specialized knowlege to assist the business achieve its goals.
- The returns reaped by an angel funder can be phenomenal, twice the investment amount on an average when successful. Sometimes, it can be over ten times of the investment amount after the exit of 5-7 years. A fruitful exit route will involve selling the business to a big fish or getting it listed.
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How does Angel Investors Work?
Angel investors are individual funders to budding enterprises. They provide funds at very early stages of their growth, usually between one to three years of their existence. Angel investors are known with many names such as seed investors, angel funders, or private investors.
The investment from private investors come in exchange for a certain percentage of equity shares, giving an ownership stake in the startup. They are high-risk bearers since they park their funds in an early-stage firm that has to make a long journey to earn a market. Many private investors are high-net-worth individuals who invest their own funds. Additionally, those with limited funds rely on fellow investors and fund through a common pool.
It enables entrepreneurs to avail extensive capital without being burdened by debts. Moreover, many angel investors hold business expertise and are from specialized fields. By extending their knowledge, they assist in the startup’s management. It lays a strong foundation for the startup to walk towards its goals. In fact, the investment decision can only emerge if the investor sees genuine growth potential in the startup. Investors make profits when shares appreciate in value either through public listing or acquisition/merger.
As per the Angel Capital Association’s report, surveying 1,659 accredited angel funders in the US, the median investment size is $25,000. However, investors with entrepreneurial experience sign bigger checks, with an average being $39,000 instead of the non-business background, whose average is $28,000. Moreover, amongst their portfolio, an average of 11 % gave positive returns. Every year, angel funders put in $25 billion in over 70,000 companies.
Angel Investment Process
- A seed investor foresees the startup’s growth potential by firmly relying on the business idea or product and betting on the founder’s commitment and dedication.
- Also, the record or success of the founders, executives and the corporate team is the angel’s interest zone.
- As such it is essential to present a strong business plan with fair valuation, viability and clarity.
- If the investor is ready to be on board with the investment, the step will involve making a term sheetTerm SheetThe term sheet is usually a non-binding agreement that contains all the essential points related to the investment like capitalization and valuation, stake to be acquired, conversion rights, asset sale.read more. It will include every crucial term of the deal. The next step involves fulfilling legal procedures, following which funds are released.
How to Find Angel Investor?
It is important to note that there are two types of angel funders – affiliated and non-affiliated. The former is an acquaintance of the entrepreneur, like wealthy friends and family members who are the closest sources of angel funding. Therefore, they are easier to find. Conversely, it is difficult to reach a non-affiliated investor as they hold no connections to the firm.
Although, there are certain ways to find the right angel investors for your business. One way is by approaching lawyers, investment bankers, accountants and other professional contacts who often hold contacts of private investors. Additionally, angel investor networks, websites, and groups like Sand Hill Angels and Investors’ Circle in the US list down their details. These platforms help bridge the gap between investors and entrepreneurs as they hold a network of angel investors.
Lastly, news platforms often feature interesting articles on top angel funders around the globe. If a business is lucky enough to score a deal with them, it will magnify their chances of success. For example, in 2013, angel investors Paul Buchheit and Jeff Clavier were among those listed by Forbes for giving a footing to many successful startups.
As a part of a firm, Paul had invested in around 61 companies such as Reddit, Dropbox and Airbnb. While Jeff using his company had invested in over 150 investments.
Advantages
Let’s go over the advantages and disadvantages that come with angel investors.
- Getting funded by the angels involves less risk for the business owners than business loans. This is because angel funds are mostly shareholders to the firm.
- Besides, the investors come with experience and knowledge contributing to the startup’s growth. In addition, seed investors associate with the company for the long term. They exhibit a personal interest in the business because they have invested their funds.
- Private investors’ end goal or exit route would come off an acquisitionAcquisitionAn acquisition is defined as the act of taking over or gaining control of all or most of another entity's stocks by purchasing at least fifty percent of the target company's stock and other corporate assets. read more or public listing of the startup. As such, they’d set the company at a stage where venture capitalists can also help the entrepreneur reach the end goal as it would make it profitable for all the parties involved.
- Moreover, angel investors with their funding and technical assistance have been influencing the growth of startups in developing countries such as India, the Phillipines, South Africa, etc. Angel investments have played a crucial role in shaping the future of many prospering startups, enabling their numbers to grow steadily. For example, in 2021, the risk capital that can be commonly found amongst angel investors or venture capitalists, accounted for 10% of the total companies that are being created in India annually. Risk capital are the funds invested in high risk projects to earn higher returns.
Disadvantages
- For entrepreneurs, availing funds from seed investors, it results in the loss of partial ownership stake (at aleast 10% and even ranging to 50% at times) in the business.
- Offering a considerable chunk of ownership to seed investors may not be sensible. It dilutes the ownership, lowering the owner’s say in the business.
Angel Investors Vs Venture Capitalists
Angel investors and venture capitalistsVenture CapitalistsVenture capital (VC) is long-term finance extended to startups with high-growth potential to help them succeed exponentially. The investors are venture capitalists who bear the excessive financial risk and provide guidance to startups to attain their objectives.read more provide capital to the business showcasing high growth potential. However, they are different from each other.
- Angel funders are individuals with the wealth to finance early-stage promising startups in their capacity. Although some of them are part of bigger groups and organizations that pool funds, the initial source is mostly through their own pocket.
- In contrast, venture capitalists are the professionally managed firms that invest in high growth potential business after the business’s basic level of groundwork. They utilize funds acquired from corporations, insurance companies, foundations, mutual fund companies, etc.
- Seed funders are active financiers and take greater risk than venture capitalists who are strategic investors . As such, venture capital is provided at the next stage of funding post angel investing.
- The amount sanctioned by seed investors is comparatively lower than those provided by venture capitalists.
Frequently Ask Questions (FAQs)
According to various research, the average earning of a successful angel investment deal is more than twice the original investment. As per a study from Angel Capital Association surveying 1,659 accredited angel investors, an average of 11% of their portfolios returned with positive earnings.
Angel investors provide funds to budding startups at the infancy stage, while venture capitalists arrive when the startup has established itself in the market to some extent. Venture capitalists pool funds from other sources, while accredited individuals primarily invest their own funds in angel investing. However, on shortage of capital, they also take part in crowdfunding.
Usually, an angel investor invests in exchange for equity. When the business becomes public through IPO or undergoes acquisition/merger, the share prices enhance. This is when investors reap profits by selling off their shares at the right time.
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