A Guide to How Do Angel Investors Work and Their Investment Process

Angel investors are high-net-worth individuals who invest their personal funds in startups and small businesses in exchange for equity.

They typically invest in the early stages of a company, often providing crucial seed funding to get the business off the ground. Angel investors usually invest between $25,000 and $1 million, with an average investment of around $300,000.

Angel investors often have a personal connection to the entrepreneur or the business idea, which can be a key factor in their investment decision.

An angel investor is a wealthy individual who invests their own capital into a startup company during its early stages of development. They receive an ownership stake in return.

Angel investors can be involved in multiple startup projects at once, and they're not just limited to providing one-time seed money. They can provide regular injections of cash to help bring a product to market.

Angel investors aren't lenders, they're investors who put their money into an idea they like, with the expectation of a reward only if and when the business takes off. This means they're taking a risk, but also hoping to see significant growth and returns on their investment.

Angel investors provide up to 90% of outside equity raised by startups, excluding friends and family. This is a significant source of funding for entrepreneurs looking to get their business off the ground.

Angel investors can be accomplished entrepreneurs themselves, bringing expertise and experience to the table. They may also have a say in decision-making to ensure their invested capital is used wisely.

Anyone can be an angel investor if they have the money and the desire to provide funding for startups. They're welcomed by cash-hungry entrepreneurs who can't get conventional bank loans.

Angel investors usually have a genuine interest in innovation and a desire to be involved. Many have been entrepreneurs in the past.

Angel investors can set up entities like limited liability companies (LLCs), businesses, trusts, or investment funds to provide funds. These entities are set up for tax purposes or legal protection.

Professional angel investors look for opportunities with a defined exit strategy, an acquisition opportunity, or participation in an initial public offering (IPO). This is because they risk losing their entire investments if the startups fail during their early stages.

If you're considering becoming an angel investor, it's essential to understand the risks and rewards involved.

To qualify as an angel investor, you typically need to meet the standards of being an accredited investor, which means your earned income must be $200,000 or more for the past two years, or your net worth, alone or with a spouse, must surpass $1 million in investable assets.

The SEC defines an accredited investor as someone with a net worth of $1 million or more in assets or who has earned $200,000 in income for the previous two years, or a couple with a combined income of $300,000.

Meeting these standards is a prerequisite for becoming an angel investor, and many startups may only accept funding from accredited investors.

Applicants must also demonstrate an understanding of sophisticated investment proposals, which can be a challenge for those new to angel investing.

Companies that receive funding from accredited investors are exempt from certain securities filings with the SEC and other regulators.

Angel investors and venture capitalists are two distinct types of investors who play a crucial role in funding startups and small businesses.

Angel investors are high-net-worth individuals who invest their own money in startups, typically at earlier stages and in smaller amounts. They commit their own capital in hopes of making a good idea a reality.

Venture capitalists, on the other hand, are employees of VC firms who invest the capital of other individuals, corporations, and pension funds. They have big money to spend and tend to invest in existing businesses that have an opportunity to turn a substantially bigger profit.

Angel investors provide up to 90% of outside equity raised by startups, excluding friends and family. They can be accomplished entrepreneurs themselves, bringing guidance, networking, and knowledge to the startup company.

Here's a comparison of angel investors and venture capitalists:

Both types of investors are looking for their investment to grow and pay off significantly down the road, which means they may keep close tabs on the startup's affairs and become involved in decision-making.

Angel investors typically invest their own funds, unlike venture capitalists who manage pooled money. This makes angel investment more accessible to startups, especially for those that need smaller amounts of funding.

The average angel investment is $330,000, but individual angel investors usually invest more modestly, between $10,000 and $200,000. Larger angel investments can go as high as $1 million and typically come from angel investing syndicates.

Angel capital fills the gap in seed funding between friends and family funding rounds and more robust start-up financing through formal venture capital. It's usually difficult to raise more than a few hundred thousand dollars from friends and family, but angel investors can invest in more than 60 times as many companies as venture capital firms.

International entrepreneurs can get funded by U.S.-based angel investors through organizations like UpWest and the Global Accelerator Network (GAN). These organizations help international startups break into the U.S. market.

To source deals, angel investors often have an established network of startup founders and entrepreneurs within their industry of expertise. They can also participate in an angel group, which allows them to tap into a community of angel investors who assess and invest in startup ventures together.

Angel investors typically look to invest during a startup's early stages, before it has received significant funding from other investors. This means you should have a solid proof of concept, such as a compelling business idea, a minimum viable product, or major customers or partnerships.

Finding the right angel investor can be a challenge, but there are several ways to go about it. You can find angel investors through your personal network, online platforms, and events in the startup community. Not every angel investor is the right match for every company, so it's essential to do your research and find someone who specializes in your domain.

The angel investing process involves pitching your business to potential investors, who may choose to provide or decline funding. The steps of this process include finding angel investors, doing your research, making the pitch, and negotiating the terms. If angel investors like your pitch, they'll offer a deal, which can be negotiable.

The process of finding the right angel investor can be a bit of a challenge. You can start by finding angel investors through your personal network, online platforms, and events in the startup community.

Doing your research is crucial to ensure that you're pitching to the right people. Not every angel investor is the right match for every company, and some specialize in specific domains like healthcare or software.

When it's time to make the pitch, founders should prepare a concise pitch deck that highlights their company's major selling points. This can be done in person or over email to set up an in-person meeting.

The pitch is just the beginning, and if angel investors like what they see, they'll offer a deal. The terms of this deal can be negotiable, so be prepared to discuss factors like the amount of equity, the company's exit strategy, and even giving investors a seat on the board.

Here are the key steps of the angel investing process:

Angel investors invest in companies during their early stages, typically after the founders have raised initial capital through crowdfunding or their own savings.

Angel investors are looking for proof of concept, such as a compelling business idea, a minimum viable product, or major customers or partnerships, before making an investment.

This means you should have a solid foundation in place, with a clear direction and some traction, before seeking angel investments.

Angel investors typically allocate less than 10% of their portfolio to angel investments to mitigate risk, as these investments often come with a very high risk of loss. Angel investors seek investments that can return at least ten times their original investment within 5 years through a defined exit strategy.

The terms of an angel investment are outlined in a term sheet, a document that defines the terms of the investment. A typical term sheet is 10 pages or less and includes details like the form of investment, voting rights, liquidation preference, and confidentiality agreements.

Angel investors can choose to purchase equity or convertible debt in a startup. Equity gives investors a percentage of ownership in the company, while convertible debt is a type of loan that can be converted into shares at a later date.

Equity is a percentage of shares that an entity owns in a business or other asset, which can be valued at the business's worth. For example, owning 10% of a $1 million business gives you a $100,000 equity stake.

Startup founders often prefer selling equity because it doesn't require them to go into debt to investors. However, to sell equity, you'll need to have some idea of the company's valuation to give a fair price for the shares.

Convertible debt, also known as convertible notes, is a type of business loan that can be converted into a given number of shares in the company. This allows founders to defer the question of business valuation until later in the funding process.

The value of convertible debt is calculated based on the company's future valuation, rather than its current valuation. Some founders prefer this option because it gives them more flexibility in their funding process.

A term sheet is a crucial document in angel investing that outlines the terms of the investment. It's usually a short document, no more than 10 pages in length.

The term sheet defines the form of the investment, which can be common shares, convertible preferred shares, or convertible debt. This is a key decision for founders, as it affects the ownership structure and voting rights of the company.

Angel investors typically seek a high return on investment, requiring a potential return of at least ten times their original investment within 5 years through a defined exit strategy. This can be challenging for founders, but it's essential to understand the investor's expectations.

The term sheet also outlines the investor's voting rights, such as a seat on the board of directors. This can be a significant consideration for founders, as it affects the control and decision-making process of the company.

A key aspect of the term sheet is the liquidation preference, which determines the order in which the company's owners will be paid if the company is liquidated or sold. This is a critical consideration for founders, as it affects the distribution of assets and the potential return on investment.

Confidentiality agreements and due diligence procedures are also typically included in the term sheet. These are essential for protecting the company's sensitive information and ensuring that the investor is making an informed decision.

Here are the typical components of a term sheet:

It's essential to seek legal consultation before signing any term sheet or other document, as certain portions can be mutually agreed to be binding.