Angel investing is attractive, but the odds of losing your money are high. So what are the benefits of angel investing? And how can you become an angel investor – even if you don’t have much money? Let’s find out.
Table of Contents:
What is an Angel Investor?
An angel investor, in the traditional sense, is someone with a sizeable amount of money who invests in other businesses–either as seed money or for growing an existing business. Like any investment, angel investors want a return on that investment, which usually comes in the form of equity in the company or a share of the revenues (or both).
How Does Angel Investing Work?
If you’ve ever seen the show Shark Tank, you already have a really good idea of what angel investing is. On the show, a panel of wealthy investors hears entrepreneurs business ideas for their startup or their existing small business.
The entrepreneurs pitching the idea are looking for an angel investment. Typically, they’ll offer part-ownership of the business in exchange for cash. An angel investor infuses cash into the business in the hopes that it grows and they make money from it.
Angel investors have ownership within the business, which usually includes decision rights. Many successful angel investors have built or invested in businesses in the past, so they have some expertise. They make decisions on how the business is run, making it more likely that the business grows.
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How Much Money Do You Need to Become an Angel Investor?
If you’re going to get into angel investing, you should have the funds to do it. Most experts recommend allocating up to 10% of your portfolio to angel investments. But this still doesn’t really answer the question of how much money you need to become an angel investor.
The easy (though probably not great) answer is that it depends on the type and size of investments you’re looking to make. Using Shark Tank as an example again, those investments can be hundreds of thousands of dollars – but the investors have it and the businesses need it.
You can invest on a much smaller scale–more like tens of thousands of dollars–depending on what the business needs. Note, though, that the smaller your investment, the smaller your share (and, in turn, profits) will be. It will also limit your ability to make decisions, which at that point it becomes just more of an investment – not what I’d consider an angel investment.
I can’t imagine working with less than $10,000. If your overall investment portfolio is $100,000, that would meet the 10% mark. But to invest good startup businesses, I would be ready with at least $50,000–meaning your overall portfolio should be close to $500,000.
But the problem is, these may not be true angel investments, or you may be investing in a small business that has more risk.
In many cases, you’ll need to be an accredited investor, which means that you have an annual income of at least $200,000 or a net worth of at least $1 million. The reason this is important is that businesses that get investments from accredited investors aren’t required to file a lot of the securities filings with the SEC and state securities regulators. Because of this, most businesses looking for angel investments want accredited investors.
There’s a debate on whether or not you have to be accredited. I personally don’t think you do to qualify as an angel investor, you just have to know where to look and accept a bit more risk (more on these two points below).
Is It a Safe Investment Option?
Not exactly. There’s inherent risk when you become an angel investor. In fact, data shows that at least 50% of angel investments lose some, if not all, of their money. On the flip side (and also outlined in that data), angel investments can produce an extraordinary return.
This sounds bad, but it’s the best parallel I can give you. When I gamble (like at the casino or sportsbook), I never gamble money that I can’t afford to lose. Meaning, I would never gamble money that, if I lost it, would put me in a bad position financially. That’s why you should stick to no more than 10% of your portfolio.
If you have $1 million in your portfolio, that gives you $100,000 to comfortably play around with. As an angel investment, you could lose all of that, but you could also hit an incredible return. So my advice is to look at it like gambling – in that you should never invest what you’re not willing to completely lose.
Remember, angel investments are much different than investing in a stock. With stocks, you have historical returns, financials, you can assess the competence of the leadership team, you have analyst opinions, and a whole slew of other information at your fingertips (if you know what you’re doing).
With angel investing, you do have some of that, but it’s a lot harder to come by. In many cases, you’ll get to see and understand the business, meet the owners, and see the financials. But what’s unpredictable is how it’ll turn out after you invest and start making decisions or changes.
Pros and Cons of Angel Investing
- Potential for very high return – Angel investing can generate returns that you will never find anywhere else. A famous angel investment is Peter Thiel, who invested $500,000 in Facebook back in 2004 before they went public. Had he not sold about 80% of his shares to date, that would be worth about $10 billion today.
- Shaping a company the way you want – Depending on the size of your investment and the deal you make, an angel investment will give you part ownership in the company and the ability to make decisions that could shape the future of the company.
- Diversification – Angel investing gives you a completely new element to add to your portfolio of stocks, bonds, ETFs, real estate, and other typical investments. You will be the part-owner of a company, and your returns will come in the form of company profits.
- High chance of partial or total loss – Angel investing is super-risky. While the potential for returns is high, there’s also an equally high risk that you can lose money – possibly all of it – if the company underperforms or goes under completely.
- It’s an investment, not a loan – Businesses like angel investments because it’s not a loan on their balance sheet. Angel investors are buying a part of the company, not loaning money. So there’s little recourse if the business fails and you lose your money–versus a loan where you could take actions to collect if it went unpaid.
What to Look for in a Worthy Investment
You absolutely have to have a copy of all the business’ financials, if it’s an established company. Look at it like you’d look at a stock – reviewing their revenues, costs, and bottom-line margins. Are their revenues declining? Are costs increasing? Where are they “fat” – meaning, do they have too much overhead (i.e., too many people)? What would happen if you reduced staff or shut off pieces of the business that weren’t profitable?
Those are the types of questions you need to ask. You need to think like an investor, but also the CEO of a company–every move you make could have a profound impact on the business and its ability to generate revenues (or even survive).
I would recommend looking at a business that has increased revenues over the past several quarters and years, while keeping the cost of sales and operations relatively flat (if not slightly increasing within reason), and margins above average for the industry. This will vary widely based on the industry, but a big margin allows you some room to make mistakes without losing the business.
I would also gravitate toward a business that had a lot of cash on hand and little to no debt. This is important since cash will help the business weather any storms without sinking their business into more debt.
Finally, get to know the business and the people running it. Is the business a good idea? Does it have long-term prospects? Can you grow it? Are there areas of opportunity that you can capitalize on? Ask those questions about the business to yourself, the owners, workers, and even customers.
Knowing the people who run the business is also critical. You want to work with someone who is open-minded and realistic about things changing. You want to make sure you have a say, and that say is put into action. Some business owners are too proud and controlling to let anyone tell them what to do–and I would stay away from those businesses.
How to Spot a Bad Investment
A bad investment is pretty much the inverse of what I described above. Owners who are controlling and don’t want to change (or say they will but are resistant). Financials that don’t look great. Debt on the books. A business idea that’s just terrible and has no growth potential.
Also important is a business you know something about. A bad investment would be in a business you know nothing about and have no interest in. If you’re investing in portable toilets, for example, it may be a profitable business – but do you want to be part owner of that business? How much do you know about portable toilets? Are you willing to stick with it for 7-10 years if you have to?
See what I mean?
Now, there are exceptions – you can find some diamonds in the rough. This takes YEARS of experience, though. It’s like finding an undervalued stock. Finding an undervalued business means that it’s in terrible shape today, but with an influx in cash and some good management, it could be turned around.
Best Places to Begin Your Investment Search
The following are a mix of crowdfunding and true angel investment clubs, all for accredited investors. At the bottom of the article, I’ve outlined some other options for non-accredited investors.
AngelList is a really cool platform that lets you invest in an angel fund – with a minimum of $50,000. Each fund contains a variety of startup businesses, so you get to own a “piece” of each of them.
FundersClub is a crowdfunding angel investing platform. Only about 2% of the startups that apply for funding through FundersClub make it through, and as an investor, the average investment is between $3,000 and $5,000. FundersClub claims they’ve seen returns of over 100% – but note that fees will cut into that (up to 30% in fees).
Life Science Angels
Life Science Angels is a true angel investment club. Since 2005, they’ve invested over $60 million in over 100 startups, and their investments typically start between $200,000 and $800,000. Membership with Life Science Angels comes with a ton of benefits.
Tech Coast Angels
Another true angel investment club, Tech Coast Angels asks that you invest in 10 to 20 new deals every year, and your investments should be (on average) around $50,000 at a minimum – which can be two investments of $25,000.
Golden Seeds is an angel investment club that focuses on women-led companies across all sectors. They don’t give specific requirements for being an investor, but they look to invest in companies seeking between $200,000 and $2 million in seed money – so it’s plausible that you’d need to be an accredited investor.
Alternatives (for Non-Accredited Investors)
If none of the above fit the bill for you, below are three popular angel investing crowdfunding platforms designed for non-accredited investors.
WeFunder is a crowdfunding angel investing platform that allows non-accredited investors. One of their taglines is that you should “invest in companies you believe in.” You can invest as little as $100 in a startup that looks interesting but you won’t have a significant amount of ownership with investments that small. You’re purely investing at that point.
SeedInvest is a crowdfunding platform that allows non-accredited investors to invest with as little as $1,000. Your minimum investment has to be at least $200. SeedInvest provides funding for startups, but only accepts around 1% of the companies that apply – so you’ll get a fairly vetted list of options to choose from. Those who have used Kickstarter will find a similar-looking platform in SeedInvest that’s easy to use.
Frequently Asked Questions
The short answer is that it’s very difficult to be an angel investor with little money. You can buy into angel funds, but angel investing is a risky game to get into, and you should be prepared to lose your money and have significant assets to fall back on.
That said, angel investing can be an investment endeavor like no other. You may hit it big and invest in a company that ends up far exceeding its potential (like Facebook). Just remember, though, that those types of companies are the exception, not the rule.