Angel Investing

The angel investor is an affluent, savvy investor who provides capital to a start-up company, often accompanying that investment with business advice. Sometimes called a business angel or informal investor, the angel typically receives an ownership stake in the form of equity, or convertible equity or debt. Exceptionally well-capitalized and sophisticated angels are known as super angels. Angels may work alone, or they may work together in groups or networks.

What's the origin of the name?

With regard to investments, the word “angel” was first used during the 1930s to describe wealthy patrons of Broadway theater shows who invested money into speculative productions previously rejected by conventional financiers. During the 1970s, the term came to be applied to early investors in technology companies whose business models and products were misunderstood, or perceived by mainstream financial firms as highly risky. As implied by the name, angel investors have been responsible for some “miraculous” business successes in recent years.

Who are they?

Nowadays, many angel investors are retired executives with entrepreneurial traits; they often have significant experience and insight in a particular business niche, and they may see valuable opportunities missed or passed over by conventional financing sources. In addition, they are often committed for reasons beyond monetary gain alone-- In some cases, angels simply want to stay involved at the cutting edge of a particular industry, and often they wish to mentor the next generation of innovators and entrepreneurs for altruistic reasons. In any case, angels are well-positioned to offer both strategic and tactical business guidance, and they often bring valuable industry contacts and credibility to fledgling ventures. Angels are usually introduced to the principals of start-up companies through industry referrals and other business networking sources, or through contacts at leading academic research institutions.


Since angels invest their own funds rather than manage the funds of other investors, and because their investments are risky, successful angels seek to lessen risk by carefully vetting prospective investments and by diversifying and spreading their capital across multiple investments. Likewise, since many early-stage ventures are considered too risky for bank loans or other conventional financing, and because many investments are entirely lost by the failure of start-up ventures, angels demand high returns in exchange for their capital and management advice. Most angels target only those investments which show the possibility of a potential return at least ten times the original amount of the investment, and the expected time horizon for success is often within five years. A seasoned angel has a clearly-defined exit strategy, which usually involves an initial public offering (IPO) or acquisition by a more-established company within the same business niche. In fact, current research regarding best practices suggests that the most-successful angels set a goal of achieving returns as high as twenty or thirty times their original investments over a holding period of as long as seven years. Of course, given the high failure rate among start-ups, the average combined net return for a successful angel portfolio may be in the range of twenty or thirty percent. Wiki

Risks and rewards

The risks of angel investing seem obvious-- A large percentage of all start-ups fail, causing a loss or substantial mark-down of the investment. Successful angels expect the outright loss of perhaps half to two-thirds of all their investments; of the remaining investments, some may break even, and a precious few enjoy stellar gains. According to a recent report by Bloomberg Business Week, in 2012 the leading twenty-five angel investors in America made approximately 970 investments in 740 start-up companies, contributing over $15 billion. Yet, for every Google there are dozens or hundreds of new ventures which fail. As in a game of baseball, with angel investing there are many "strikeouts" and the winning teams become successful by maximizing their occasional "home runs." Still, many leading angels have asserted that their greatest reward lies in helping important new technologies reach the marketplace.

Implications of the JOBS Act for angel investors

The Jumpstart Our Business Startups (JOBS) Act was signed into law in 2012, and its Titles I and III have significant implications for angels who invest in American businesses. The JOBS Act seeks to streamline the process through which early-stage companies obtain capital, while ensuring disclosure of pertinent background information. Most importantly for the angel-investor community, the Act lifts the ban on general solicitation of investments for securities, provided that all buyers are accredited investors. This change allows entrepreneurs to reach a much broader audience of potential angels, especially by using electronic communications. And, the new rules also facilitate the syndication of deals through angel networks and crowdfunding platforms. Still, the wording of the JOBS Act also makes clear that sellers of securities must verify that all buyers are accredited investors. In the past, issuers typically relied on broker-dealers or self-certification by sophisticated investors. Yet, under the new scenario, when small issuers such as start-ups advertise through the general media, they often attract interest from both retail investors and angels alike, and the burden is on the issuer to ensure that their securities are sold only to accredited investors. Although these legal provisions were designed to prevent sales of risky securities to unsophisticated retail investors, the result may be that angel investors are faced with a burden of disclosing and proving their own financial qualifications before they can invest in start-ups. The JOBS Act envisions that angels may self-verify their status as accredited investors by disclosing detailed financial information including tax returns or certified financial statements, yet it remains to be seen whether these disclosure requirements are palatable to large numbers of prospective angel investors. Angels may find it disadvantageous to disclose their own financials to the prospective investment targets with whom they negotiate.

Funding rounds: Seed money, angels, and the “A” round

As the name implies, “seed money” is a very early investment in a start-up company which allows the business to sprout. Before the seed round, a company is likely so new that it has no marketable products and services-- only founders with ideas. Seed money pays for preliminary expenses such as market research and early development. This funding may come from friends and family of the company's founder, or it may come from angel investors. Once the seed money is invested, a comprehensive angel round of funding may sometimes be undertaken, during which the company makes a more coherent presentation to a wider group or network of angel investors in order to secure more funding, and perhaps also build a broader base of management support and mentoring from veteran angels. The next stage of investment in a young company is the “A” round financing, sometimes called Series A financing because it is the time for issuance of the first, most-desirable preferred stock series. The “A” round typically occurs once the company's founders have already progressed through the stages of fully investing their own resources (including those of family and friends), as well as having already received enough money from angel investors to empower the company to show a “proof of concept” to seasoned institutional investors who may provide “A” financing.

Deal structure

The “A” round brings major changes in the ownership structure of the deal. Savvy investors and institutions that provide “A” round financing typically demand convertible preferred “A” stock instead of common stock, hence the name. During this round, the company receives sufficient investment funding to launch the company into rapid development and growth. Preferred stock gives “A” investors certain advantages, including a higher level of stockholder rights, as well as dividend accruals, and it allows them to later convert their holdings into common stock which may become quite valuable if the company becomes highly successful. Yet, by the issuance of new “A” series convertible preferred stock or other securities, the holdings of the founder and the angel investor are greatly diluted. The “A” round is an important milestone for angel investors, since their investment gains from successful companies may be very large, and this round signals the beginning of rapid development toward that goal.

Straight equity investment

Considering the equity dilution that results from issuing convertible stock, for investment rounds after the initial investment many angels and other investors favor straight equity investment or a fully priced round of financing instead of convertible stock or debt. Since angel investors take the earliest risks and provide critically-important credibility, mentoring and management, they may wish to be avoid being penalized during the “A” round or subsequent rounds of funding. A straight equity investment offers both advantages and disadvantages: It can avoid publicity, and the sometimes-complex documentation that would be required for (perfected) security interests such as convertible debt. Still, a straight equity investment may invoke an even longer process of documentation and negotiation. As well, a straight equity investment also requires that the company's value be set at a fixed price per share, although angel investors may wish to defer the pricing of the shares until somewhat later in the company's development. In summary, it can be said that angel investors have an important role in nurturing and guiding start-ups and early-stage businesses, and they are well positioned to profit from their foresight and willingness to take risks.