Angel investing is when an individual invests their capital in a business or start-up. According to angel investment network, there are currently over 250 000 active US angel investors, and that number is growing every year.
It’s not a surprise that angel investing has become so popular since so many benefits come with it.
Giving back to the community
For serial entrepreneurs who had a significant exit or built successful businesses, angel investing can be a great way to give back, get involved, and help the entrepreneurial community grow and flourish.
Staying up to date on innovation
Financially backing a start-up can be incredibly intellectually stimulating. It presents the angel with a tremendous opportunity to contribute to innovation and keep up to date on new social trends, technologies, and sometimes essential world changes.
Mentoring other entrepreneurs
Angel investing often goes hand in hand with mentoring younger entrepreneurs, which can be fulfilling work. Often, an angel investor has enough experience under the belt to relate to the day-to-day challenges of a young business owner. A relationship like this can dramatically influence the trajectory of a business profoundly.
Of course, start-up investing can bring incredible returns to angel investors. As with every high potential reward, direct equity investment in start-ups also comes with a high risk of loss. As part of a diversified investment portfolio strategy, being a private seed funder can significantly contribute to increasing angels' wealth.
In short, start-up funding as a business angel offers flexibility and freedom of choice compared to investing through a VC fund as a limited partner. Angel investing is also a great way to achieve a vast return on investment by contributing to the “real” economy.
If you want to start investing as a business angel or are looking for more opportunities to be involved as an angel seed investor, there are several ways you can do it.
Direct equity investment as a solo angel is the most straightforward way to invest in a venture. By solo angel, we mean the investor is the only person to provide the financing.
The most common case for this type of investment is for an angel to invest a ticket ranging from $10k to $100k very early. This occurs either right after or instead of “love money” in the pre-seed funding stage ("love money" refers to any initial cash extended to the business by family and friends).
Except for solo angels that are incredibly wealthy and would be able to cover a full round of investment above $100k by themselves, these types of investments are sourced through direct personal connections. This initial capital is required to explore a viable go-to-market strategy or, in some cases, product research and prototyping.
In a direct equity investment, the angel investor invests in exchange for common equity in the business and becomes an early shareholder.
Preferred shares are slightly more sophisticated and investor-friendly than common shares.
The principle of preferred shares is to give special treatment to their holders. The most prevalent one is that if the company sells, holders of preferred shares receive 100% of the proceeds up until they receive X times their initial investment.
Preferred shares can also be structured to attract an equivalent interest each year, either paid in cash or in kind.
As a start-up angel investor, preferred shares are usually used to limit your downside risk. They are very typical among Venture Capitalists, and as an angel, you can negotiate these kinds of terms if you bring a clear sense of value to the start-up.
As an angel investor, investing in a start-up or business by giving it a loan is technically possible. However, it is less common than other instruments because cash-intensive start-ups tend not to be a compatible business profile for debt (which generally requires yearly cash outflow to pay interest and repay the principal).
Some loans with special conditions may be more suitable for cash-burning start-ups, like loans whose principal is repaid in fine with only interest paid each year or interest accrued. The main difficulty with that type of structure is that the level of interest would need to be very high to compensate for the risk a lender takes, especially considering that a lender would not benefit from any upside in case of overperformance of the business.
The main scenario where a start-up would consider a loan from a business angel would be when the company is looking for a bridge loan. A bridge loan is usually used when a company is actively raising a good round of funding but needs cash quickly to cover day-to-day expenses and net working capital. A bridge loan is typically meant to be paid back once the whole equity round has been raised.
In the case of a bridge loan, angels who provide the loan can negotiate the right to participate in the entire round and potentially request preferred terms, like a slight discount on the valuation.
Angel investors and VCs more commonly use convertible notes than loans.
The principle of a convertible note is to act as a note, attracting interest, unless the holder decides to convert it to equity based on a pre-agreed valuation.
Convertible notes can be very investor-friendly, giving angel investors the best of both worlds between debt and equity. If structured well, in the case that the company does not perform as planned but still survives, the angel investor will receive regular interest payments and get paid back his initial investment. However, if the company overperforms, the investor can convert his note into equity and benefit from the upside.
Convertible notes can also be structured in a way that is a bit more favorable for entrepreneurs. For instance, convertible notes can include buy-back clauses which give the start-up the right to repurchase the notes from the investors before its term.
Another way a convertible note can be more entrepreneur-friendly is in a scenario where it removes the possibility of the business defaulting on the note. In the event of a potential default, the business and angel can agree that the note is converted into equity instead of forcing the business to go bankrupt.
When a default happens, the agreement is usually structured so that the convertible note holders have more significant control of the company's operation and strategy, at least until the company makes a comeback and becomes profitable again.
SAFE, or Simple Agreement for Future Equity, is an agreement that promises the investor that they will receive equity in the company later, based on the valuation of the company at that point.
SAFE’s equity conversions are based on a % discount and a valuation cap. For instance, a SAFE agreement could say, "you are investing $50k in my company today, and that $50k will be converted into equity at a valuation 20% lower than the valuation of the next round of equity fundraising, understanding that they will convert at a valuation lower or equal to $10m.”
Generally, events that can trigger the issuance of shares are equity fundraising, the sale of the company, or an IPO.
SAFE is very common in the US and has been created, or at least made popular, by Y-combinator, one of the most famous incubators in the world.
SAFE is an excellent way for a business angel to invest in a company they believe in while avoiding the hassle of agreeing on valuation and going through the pain and costs of putting together all the legal paperwork.
First, not all angel investors are necessarily valuation experts, and second, even when they are, it can be challenging to come up with a fair price for a very early-stage company. By investing through SAFE, angels can focus on helping entrepreneurs with their strategy and execution plan while leaving the valuation discussions to the experts in the next round.
KISS or "keep it simple security" are a mix between a convertible note and a SAFE. If given a choice, investors will likely prefer KISS over SAFE. In the same way, convertible notes are generally preferred by investors over common equity.
Because of the same reasons described above regarding debt, early-stage start-ups may not, however, be so keen on having to pay interest when they are not yet generating positive cash flow.
Many business angels become business angels because they have started or managed their own business before and can bring a tremendous amount of skill, knowledge, and network to the companies they would like to back.
Also, not every start-up needs considerable cash to burn to get off the ground. For many young entrepreneurs, having an experienced mentor and a robust network to tap into is way more valuable than cash alone.
When one of these start-ups meets a Business Angel who sold their business or moved away from their previous ventures and is ready to dedicate some of their time to be operationally involved, they can do so in exchange for equity.
Crowdfunding platforms have been a small revolution in the world of start-up funding. The regulator has made a lot of progress toward allowing everyday investors to invest in high-risk start-ups while maintaining strict regulations to protect non-sophisticated investors (also known as Reg CF).
Some of these platforms have raised funding to accelerate their growth, demonstrating the overall appetite for crowdfunding.
If you would like to start as a business angel but do not have the financial capacity to invest $25k per deal, it is possible to start on these platforms for as low as $100.
Investors like to find proprietary deals in which they can privately invest. But they also like when other investors get in on the action alongside them. Social proof is essential in instilling confidence in investing in a risky, early venture.
So naturally, angel groups sprouted up for business angels who like to add a bit of process to their investment decision and rely on the expertise of other investors to inform better decision-making.
There are many types of angel groups:
These angel groups can all have their own rules, but the way they usually work is that every member can submit a new investment opportunity to the group. Suppose the opportunity matches the high-level criteria to be attractive to the members. In that case, the founder is invited to a quick pitch that can last from 5min up to 30min, including Q&A. Then the individual Business angels who are interested in investing come forward, work hand in hand to do their due diligence, and negotiate terms.
Some groups are organized by the sum of all the individual interested business angels involved in the deal, and each business angel will individually invest directly in the company. But other groups may prefer to invest as a syndicate, which acts more as a unified front with all business angels investing under the same terms, and potentially through the same legal entity like a holding or Special Purpose Vehicle (SPV)
Many Business Angels like the proximity with the entrepreneurs and like to be involved in the projects they invest in. However, many struggle to find the right opportunities to invest in or don’t have a solid deal sourcing process.
Independent sponsors are investors sourcing, negotiating, and executing deals that do not have funds under management. Instead, they rely on their network of investors and LPs to finance their deals on a case-by-case basis.
Thanks to their flexible investment model, independent sponsors can offer business angels to join them as Limited Partners but will also sometimes welcome their strategic or operational input.
One thing that differentiates independent sponsors from private equity investors is that independent sponsors are significantly involved operationally in the companies they acquire. As such, having a business angel with industry expertise as part of their financial investors may be very valuable to them.
Incubators help start-ups get off the ground; their end goal is to see these start-ups raise funds.
Incubators are part of the whole investment ecosystem and like to involve experienced entrepreneurs to mentor their start-up founders. Incubators can be a great place for business angels to get involved in early-stage opportunities.
Business angels involved with incubated companies develop a special bond with entrepreneurs and get a better, earlier understanding of the company's value proposition. Their proximity to the organization also gives them a higher understanding of the quality of the team. Incubators might arrange the first right of refusal with angels in exchange for mentorship or public speaking engagements.
A less popularized method of seed funding from angels comes from retirement accounts. Some angel investors deploy large amounts of retirement capital into start-ups through self-directed IRAs.
Learn more about investing in private companies with retirement money.
A business angel’s investment style will depend on three main factors:
How well connected you are, your level of wealth, the amount of time you are willing to dedicate to advising companies, and your reputation in your industry will influence your path as an angel investor. The “best” investments, however, are typically ones that you believe in financially, morally, and interpersonally.
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