An Angel investor (also known as Angels) is a well to do individual that provides funding for business start-ups in exchange for convertible debt or ownership equity. If an you decide to become an Angel it is imperative that you are financially well off, because Angel investments rarely achieve outsized financial rewards. In fact, investment failures are more common than successes. David McClure who previously ran the FF Angel Seed Fund estimates that less than 10% to 20% of Angel investments become profitable. The percentage of Angel financed companies that become huge successes is even smaller. Less than 0.2% of Angel backed companies become IPO’s and less than 1.5% end up as acquisitions. Since Angel investments are highly risky, these investors search for investments with the potential for a very high rate of return.
While there are certainly a good number of Angels that have the confidence to invest on their own, the trend is towards Angels forming investment groups. As a group Angels can better evaluate investment opportunities, and negotiate better terms when they do invest. When Angels form a group they can benefit from their combined business experiences and perspectives. Also, deal flows are generally larger and of a higher quality when done through a group, than when done by an individual.
Another advantage of investing through a group is that it offers Angels more opportunities to diversify. Angels often acknowledge that since they cannot pick winners with a high degree of certainty, having a diversified investment portfolio gives them a better chance of being successful. When Angels invest through a group they control more money and therefore, find it easier to diversify. After all, having a diversified portfolio gives investors a better chance to pick one of the few phenomenal winners that can make up for the losing investments.
Getting started as an Angel Investor
Becoming a successful Angel investor is a learning process. Investors that have available cash often start off as individual investors and join investment groups once they have learned the ins-and-outs of the business. As a beginning Angel you will want to learn:
How to pick the right companies: This includes learning how to evaluate the most important investment consideration which is the quality of management. Learning to evaluate a business’s growth potential and proprietary product demand are also essential parts of the learning experience.
How to protect yourself against ownership dilution: If a business becomes successful, it is likely to attract new investors. Therefore, it is important to draw up a viable business contract, with an anti-dilution provision.
How to protect yourself against liability, if the company does not succeed: Investors can decide to set up any type of legal business structure they like. However, you should consider setting up a Limited liability company (LLC) or buying liability insurance, if you want to protect yourself from additional liabilities beyond your own investment.
Joining an Angel Investment Group
When you decide to join an investment group, there are several strategies that will help you to find the best group for your needs.
Talk with someone that you know who is already in a group. If you cannot get in this way, bring some unique value to the group other than your money.
If you do not have an inside connection to an Angel investing group there, are several resources that will help you to make a connection. Two are listed below:
National Angel Capital Organization
When searching for an Angel group it is important to carefully evaluate the group’s credentials and expectations. First you will want to check the group’s credentials, after all not everyone who says that they are an angel investor is actually who they say they are.
Following is a short checklist of what you should look for before getting involved with an Angel investing group. If an investor tells you that he is just getting started in Angel investing, this should be considered as a red flag. If an investor says that he has been investing for more than a year, ask him to name the companies that he has invested in. If he is able to name companies then call or email the companies and ask to speak to the founders. Rely on your instincts, do you know or trust the people that you are dealing with. Practice due diligence, carry out a history check. If an investor is legitimate, they will not be offended by you taking precautions.
You will also want to evaluate the groups time and investment requirements, as you may be expected to spend a lot of time or meet minimum investment standards.
Conclusion
While the rewards from Angel investing can be phenomenal, you should never forget that the risks are substantial. That is why you should always practice due diligence, and never put more money into an Angel investment that you can comfortably afford to lose.
Resources:
http://techcocktail.com/angel-investing-part-1-2011-08
http://failuremag.com/feature/article/fools_gold/P2/
http://www.gobignetwork.com/information/angel-investors/angel-investor-network
http://www.gobignetwork.com/information/angel-investors/angel-investor-network
http://www.davidgcohen.com/2011/04/25/clarifying-beware-of-angel-investors-who-arent/
Darnell Brown is an accountant with over 20 years of auditing experience. He has worked in both the private sector and for the United States Government. He currently works as a freelance writer and has written numerous financial articles for the investmentunderground.com website.