Who are angel investors?

Angel investors or business angels invest their own money in a startup company at the early stages of development (pre-seed, seed). In the early stages of a company's existence, the risks associated with its growth and survival, and therefore the return on investment, are very high. For this reason, investments in startups account for no more than 10% of an angel's investment portfolio. However, the risks are offset by the potential for significant returns if the company is successful. As a result, an angel investor's main goal is to make a profit by increasing the value of the investment and selling it in later rounds.

Angel investment provides the startup with its first source of funding. This allows the startup to develop the product, build a team and prepare for the next stages of attracting investment.

It is worth noting that an angel investor may not be actively involved in the startup's activities after investing; they may be passive, providing funds but not participating in decision-making, management, or operational processes.

How does it work?

Characteristics of angel investors

If we were to draw up a 'portrait' of an angel investor, they would be:

• Often successful entrepreneurs or top managers of large companies who invest some of their capital in startups to diversify a portfolio;
• Typically, angels invest in startups immediately after FFF, when other sources of funding, such as venture capital funds, are not yet available;
• The amount of investment from angels is much smaller than from venture capital funds, but it all depends on their individual capabilities;
• Angel investors help with their experience, contacts, and advice. This is called 'smart money'. Frequently it is not the money that is much more important, but the capabilities, such as the angel's networking and expertise, that will help find the first customers, venture capitalists and partners;
• Unlike VC funds, angels make faster investment decisions because they are guided by their own insights rather than complex internal processes.

Angel investors typically do not require large equity stakes or full control of the company.

Why seek an angel investor?

Startup founders have several reasons for seeking out angel investors:

• Access to capital. For early-stage startups, traditional sources of funding (banks, venture capital funds) may not be available, so angels become the first source of money;
• Help and mentoring. Angels can share their expertise, help connect with other investors, partners and customers;
• Flexible investment terms. Angels often offer more flexible terms than venture capital funds. This can be advantageous for startups who don't want to lose a significant amount of control over the business;
• Preparation for the next stages of funding. An angel investment can prepare a startup for further stages of expansion when the company reaches a certain growth point or shows more results.

Origins of angel investors

The term 'angel investor' originated in the United States in the early 20th century and was originally used in the theatre. Producers would approach wealthy patrons of the arts (called 'angels') to finance theatre productions. These people would invest in these productions, hoping to profit greatly if the play became popular.

Over time, the term moved into the business world as private investors began to fund early-stage entrepreneurial projects when companies still needed access to traditional sources of funding such as banks or institutional investors.

The popularisation of angel investing is closely linked to the development of the technology industry and Silicon Valley. In the 1970s and 1980s, with the rise of startups, especially in the technology sector, there was a need for seed capital. As VC funds were not yet investing in pre-seed-stage companies, there was an opportunity for private investors.

The success of companies such as Microsoft and Apple, which were also initially backed by private investors, encouraged many to embrace the idea of angel investing. They saw the opportunity for significant capital growth with a relatively small investment in the early stages.

Then specialised angel investor organisations and networks began to emerge, where experienced business people or former entrepreneurs helped young companies not only with capital but also with knowledge, mentoring and business contacts.

Who can become an Angel Investor?

Anyone with sufficient capital and a willingness to invest can become an angel investor. However, these are usually:

• Individuals with significant income and spare capital for risky investments;
• Many angels are former entrepreneurs or managers who have been through the journey of starting and growing their own businesses. They have the experience to help assess startups’ potential and support them not only financially but also through mentorship;
• Business angels are willing to accept a high level of risk and the possibility of losing their investment in exchange for a potentially high return;
• Angels often have not only a financial interest but also a desire to help develop innovative ideas or businesses that change the market or create new opportunities.

Accreditation of Angel Investors

In some countries, such as the United States, angel investors must meet certain criteria to participate in investment transactions, i.e. to be 'accredited investors'. Accreditation is a legal process that determines whether an individual can invest in private companies and high-risk projects.

Accreditation rules protect unsophisticated or less knowledgeable investors from taking excessive financial risks. It also protects companies from investors with questionable sources of funds or inadequate qualifications.

Take, for example, the accreditation requirements for angel investors in the US:

• The investor must have a gross income of more than $200,000 per year (or $300,000 in the case of joint income by spouses) for the past two years. There must also be a reasonable expectation that this income will remain at that level in the current year;
• The investor must have more than $1 million in net worth (excluding primary residence);
• In some cases, individuals may be accredited based on professional knowledge, experience or certain certifications.

The principle of accreditation is to limit access to risky investments to those who have sufficient resources to absorb potential losses. In most cases, accredited investors have access to a wider range of opportunities, including investments in early-stage startups.

Where do angel investors get their money?

Angel investors usually raise money from their own sources of income and wealth. The main sources of their investments are:

• Many angel investors are former or current entrepreneurs who have built successful businesses and sold them for large profits or continue to generate significant income. They use what they have earned to invest in startups because they understand how early-stage businesses work;
• Angel investors may accumulate wealth through long-term investments in other assets such as stocks, bonds, or property;
• Some angel investors inherit money that they use to invest;
• When an angel investor has successfully invested in a startup and made an exit, the sale of his or her stake can yield significant profits that he or she reinvests in other businesses;
• Angels can also accumulate significant capital through their professional activities. For example, top managers of large companies earn high incomes, which they use for private investments.

Angel investor investment profile

An angel investor's investment profile is a set of characteristics that identify the companies in which they invest, the approach to risk management and the expected level of return.

The key aspects of an angel investor's investment profile:

• Investment stage. These are typically pre-seed (when a startup may not yet have a product or revenue and is looking for funding to get started) and seed (when a startup already has a prototype or minimum viable product — MVP — and needs funding to scale further);
• Size of investment. Typically, angels invest anywhere from a few thousand to a few hundred thousand dollars in a startup. The average investment can range from $25,000 to $250,000 per deal;
• Industry specialisation. Industries in which the angel investor has an interest, expertise, and network;
• Duration of the investment. Once invested, angels cannot pull out the funds at will, so they need to be clear about how long they intend to keep them as a stake in the company;
• Level of involvement. Some angel investors tend to take an active role in the development of the startup, providing mentoring support, helping with business processes or using their networks of contacts. Others take a passive role, providing only financial resources without getting involved in the day-to-day running of the business;
• Mission. Sometimes angel investors focus not only on financial returns but also on cultural and social innovation. They may invest in projects that align with their values, such as sustainability, social entrepreneurship or philanthropy.

What kind of ideas do angel investors fund?

Angel investors tend to fund startups and business ideas that have high growth potential, an innovative approach and the ability to scale. It all depends on the profile of the investor, the market situation, the hype, and several other factors. They typically look for:

• A strong founding team with experience, passion, and the ability to execute the vision;
• An innovative idea with a clear competitive advantage and scalability;
• A large market;
• A financial outlook with realistic revenue projections and an exit strategy;
• A product or MVP that already has feedback or traction in the market.

What is the difference between angel investors and venture capitalists?

Angel investors and venture capitalists play an important role in funding startups, but they differ in some key ways:

Investment stage:

• Angels: Pre-seed, seed
• VCs: Seed, Series A and beyond

Investment size:

• Angels: $5,000 — $250,000
• VCs: $500,000 or more

Source of capital:

• Angels: Own funds
• VCs: Third-party funds (LPs)

Level of involvement:

• Angels: Mentorship, active participation
• VCs: Strategic support, board seats

What are the disadvantages of angel investment for an entrepreneur?

Some main disadvantages for the entrepreneur in raising angel investment are:

• The entrepreneur is usually giving away a stake in his or her own business, albeit a relatively small percentage;
• Angel investors may want to be actively involved in decision-making or influence strategic issues of the business. This can lead to conflicts between founders and investors if they have different visions for the business;
• While angels can provide valuable advice and a network of contacts, their financial resources are limited. This means that the startup will still need to seek additional funding;
• Investors may wait a period for an exit from the business to recoup their investment. This can affect the company's strategy, forcing the founders to consider selling the business or raising the next round of funding sooner than they are ready.

Conclusions

Angel investors are important in the early stages of startup development. They typically invest their own money in pre-seed or seed-stage projects when other sources of capital may not be available. Their involvement provides not only funding but also mentorship, experience and a network of contacts.

Angel investors may be high-net-worth individuals with available capital and a willingness to invest in high-risk projects.

The investment profile of angels varies, but they are often looking for promising ideas capable of rapid growth with a strong founding team. Their motivation may include not only profit but also a desire to support innovation, gain new experience or help young entrepreneurs.

Disadvantages of angel investment include the need to give up equity in return for a small amount of funding, conflicts with investors and a potential reduction in the entrepreneur's autonomy.

In conclusion, angel investment is a valuable tool for early-stage startups, but certain risks and limitations need to be considered when raising funds.