Is Angel Investing Right for You?

By Eric Pozzo & Bob Ward

We've all heard the stories of early investors in concept stage companies that have gone on to become millionaires. You might have passed on an opportunity and with later regret wondered "If only I had invested in ..."

This article should help you understand if angel investing is right for you and whether your investment portfolio should include some early stage investments.

What is angel investing?

Often companies get started with the help of small amounts of money contributed by family and friends. However, many promising companies require significantly more capital than can be provided by this source. Angel investing involves individuals providing early stage capital for the start-up or growth of a small company. An individual "angel" may invest thousands to tens of thousands of dollars into a capital fundraising round that may range from less than $100,000 to several million dollars or even more.

Angel investors must be "accredited" and meet certain legal requirements before investing. Generally, an "accredited investor" is an individual with a net worth of $1 million or more, or with an annual income of $200,000 (or $300,000 combined with their spouse). Legitimate investment opportunities represented by credible law firms will require that the angel investor complete the appropriate paper work verifying they meet the definitions of accredited investor.

But just because you meet the definition of an accredited investor, doesn't mean angel investing is appropriate for you.

High risk for possible high returns but...

A key consideration for angel investing is to only commit funds you can afford to lose. You must be comfortable with not having access to the money again for a long time, if ever. Starting and funding a new company is always a high risk enterprise and angel investors are involved at the riskiest stage. Although being accredited requires a net worth of $1 million, this may not mean you can afford or feel comfortable losing $5,000, $25,000 or more. One rule of thumb is that unless you have a net worth greater than several million dollars, perhaps you should not be angel investing, or if so, at modest amounts.

Like most sound investment strategies, diversification is prudent. A high percentage of start-ups fail. For every ten companies that receive angel funding, seven often fail, two may achieve modest success, and if lucky, one may be a winner. Like the stock market in general, it is extremely tough to pick the one winner. So if you decide you are comfortable with the high risk of angel investing, spreading the risk among multiple opportunities can be a sound strategy. If you've decided to commit to angel investing, spreading this among five or ten opportunities could increase your odds of having stock in a winner.

Often angel investors have enjoyed successful careers and have far more to offer than just capital. Do you want to invest your time and experience as well? This can often be very valuable in helping both the company and yourself in deciding whether to continue with future funding of the company.

Other important considerations are liquidity and time horizons. The typical angel investment has no liquidity, or opportunity to get your money out, until there is a "liquidity event." This is when a company is acquired, goes public or otherwise funds the buy-out of the early investors. The typical time horizon for the few companies that survive to a liquidity event is 7 years or longer.

So, in many cases the value of an angel investment goes to zero, and you have little ability to get your investment out as you watch the company struggle. Even successful investments usually take many, many years to provide a return on the investment.

So why invest?

Some companies do succeed and occasionally provide astronomical returns on the investment. But as this is rare, you should also consider other motivating factors. If you have an appetite for risk, you may view this as an educated form of gambling (e.g. Las Vegas where your business experience can increase your odds). There is often a real vicarious thrill of participating in the roller coaster ride of the typical start-up. You've got money in a race and betting on a team that is doing the hard, day-to-day work of growing a company. If you've decided to invest your time as well, you may be part of helping this team succeed and enjoying the emotional rewards of this participation: "The thrill of victory, the agony of defeat" on the playing field of entrepreneurship. It is also a way of giving back to a community that may have helped you get started earlier in your career. It can be educational as you evaluate new market niches and technologies, interact with stimulating co-investors and management teams, and all the other activities involved. It can and should be fun!

In summary, angel investing is a very risky proposition and you need to evaluate if it is right for you. If you have an appetite for risk and have funds you understand might be lost or tied up for many years, angel investing can be financially and emotionally rewarding.