Updated: November 1, 2020
There is no prerequisite to becoming an angel investor, but it helps if you are an accredited investor. This means you can deal in securities that are not registered with the financial authorities.
This is possible for investors who satisfy several requirements about income, asset size, net worth, and professional experience or governance status. You may be wondering how does angel investing work.
What Is Angel Investing?
An angel investor is a person who would like to invest his or her personal funds in a startup in its early stages. There is a certain amount of risk in this type of investing after all many startups don’t make it big, so it usually comprises only about 10 percent of the angel investor’s financial portfolio.
The aim of angel investing is to help a new entrepreneur get started. Unlike a venture capitalist, the angel investor is not focusing on the possible future profit. They exchange the investment for convertible debt or ownership equity.
Most angel investors have some extra cash that they would like to invest to get a better return than they get in a traditional investment.
How Does Angel Investing Help Businesses?
Angel investors are a huge boon to people who want to start a business and are looking for financing. They give more favorable terms than banks and other lenders or investors. Angel investors look at the capability of the entrepreneur more than at the viability of the endeavor.
For many startups, angel investing is the sole source of their financing because they want to avoid giving away too much equity at the beginning or paying huge interest rates for a loan.
Benefits of Angel Investing
Angel investing can be risky, but according to The American Angel, you can build an angel portfolio that yields a 75 percent possibility of a 2.6 times return on your investment over five years. The most common investment is $25,000 – $36,000 but investments vary from $5,000 – 100,000.
The benefits for startups are even better. There is no need to have personal assets or collateral. The entrepreneur has access to the angel’s contacts and advice.
This means access to the angel’s knowledge and management skills. In some cases, the angel will mentor the entrepreneur. Whether or not the endeavor is a success, the entrepreneur does not need to repay the investment or any interest.
Things to Know Before Becoming an Angel Investor
Angel investing can be very satisfying both personally and financially and is certainly a benefit to a startup, but before you jump into investing, here are a few things to consider according to Forbes:
- Understand the risks for each investment. When you listen to a pitch by an entrepreneur who wants funding, the most important thing to note is how they express the vision for their company and how to implement their business plan to achieve this vision.
- Learn from investors who have been successful angels by joining a local angel group. You will also get access to some of the best investment opportunities.
- Examine the business system. This will tell you how all the intricate parts of the business work together to solve problems and make policy. Entrepreneurs must incorporate an effective business system to have strong building blocks of the company. The business system must also be efficient and accurate.
- Make sure the entrepreneur can make a success of the business. Don’t invest with the idea that your expertise will save the day.
- Understand that in most startups, the original business idea usually changes. This is called a pivot and the entrepreneur should be ready to make the necessary changes.
- Passion and know-how are essential for an entrepreneur, but for the angel, a solid business plan is the most important element. It should include a road map for the future and in-depth market analysis.
Angel investors are good for overall economic growth and create many jobs. They encourage individuals to go forward with innovations and ideas to start a business. If you are considering becoming an angel investor, you may well ask how does angel investing work.
Done right, it’s a win/win situation for investors and entrepreneurs to get a good financial outcome.
This article is contributed by Marcus Wiseman.