The investment world is divided into two broad camps. There are those who want to see their money grow steadily, but without taking any major risks. And then there are those looking to strike it rich by getting behind “the next big thing.”
Fitting squarely inside this second group are angel investors, the folks who fund promising startup businesses in the hope that they’ll pay out several times the initial outlay. Usually that happens when the company is sold to a larger firm or decides to launch an initial public offering (IPO).
While angel investing might sound exciting, it’s not for everyone. The main barrier is actually a legal one. You have to be what’s known as an "accredited investor,” which means you have to have $1 million in assets (not including your main residence) or bring in upwards of $200,000 a year. In other words, you have to be fairly well off before you qualify to try to strike it big with the next Facebook or Alibaba.
In reality, you usually need even more wealth than that. Because even the savviest angels lose money on many of their deals, they usually back at least 10 to 20 different companies. With typical investments in the $25,000 to $50,000 range, it takes at minimum $250,000 just to get started.
It takes more than an impressive bank account to become a success at the angel investing game, however. The ones who do best are often people who have worked in the same industry as the company they’re supporting. Such individuals understand the market and have a better grasp of the business’s growth potential.
Angels with industry experience also tend to have a professional network that company founders can tap into to try and take their venture to the next level.
Doing Your Homework
The third thing you need to enter the angel investing world is time. Unlike companies that are already trading on an exchange, there’s relatively little you can find about a startup online.
Hence, many early-stage investors like to meet face-to-face with the company’s management team to better understand their goals and drill down into the company's financials.
As much as anything, angels need good judgment about whether the founders can actually make their vision a reality. If they don’t have skill sets that complement one another – or if they’re at odds over the company’s direction – that’s probably not going to happen. Also be sure to investigate each of the founders to be sure that their description of their background and experience matches what they've actually done and to see whether whether there were any questionable issues in their previous projects. If you find a failure or bankruptcy, determine whether it's germane to the project you are considering. See What are the due diligence basics for investing in a startup?
High Risk, High Reward
Early-stage investors tend to be optimists by nature, so it’s important to understand some sobering stats. According to the U.S. Census Bureau, roughly half of all startup businesses fail within a few years. Among the rest, only a small fraction provide the big returns – at least ten times the initial investment – that angels target.
Needless to say, it's not in your interest to take money you’re counting on for retirement or your kid’s college tuition and put it into a brand new venture. If you do jump into angel investing, most experts suggest diversifying as much as possible. That increases the odds of getting into a stellar investment that more than makes up for the clunkers.
Even when the company does well, investors shouldn’t expect a quick payday. On average, it takes 5 to 10 years for firms to either find a buyer or cultivate enough interest to have a successful IPO.
Getting started in angel investing is easier today than it’s ever been. It used to be that funders had to join an angel investing group, which meant attending meetings and paying a membership fee. Many of these groups are invitation-only, so you often needed the right connections just to get in.
But over the past few years, online syndicates such as AngelList have started popping up, allowing you to invest in a more direct manner. A “lead” puts up a big chunk of the overall investment and writes a thesis about the company. Other investors can then decide whether they want to become “backers” of the business with their own money.
Online crowdfunding forums are not only changing how people invest, but how much they’re contributing. Depending on the site, it’s possible to become an angel with as little as $1,000 per company, a far lower barrier than in the past.
Does that mean it always make sense to invest online? Not necessarily. Joining a more traditional syndicate can be a valuable experience, especially for newer angels who are trying to learn the ropes from a seasoned pro. Before putting up any cash, be sure you thoroughly research the angel syndicate or lead investor and are comfortable with their track records.
The Bottom Line
Angel investing can be an exhilarating process. But even if you qualify as an accredited investor, early-stage investing isn’t for everyone. Startups only succeed about half the time – and even when they do, it can take several years for investors to cash out their position. For more information, see Cashing In On the Venture Capital Cycle and What is the difference between private equity and venture capital?