Angel Investing Explained
First published April 4, 2018. Most recently updated, July 19, 2022.
Overview
Important Notice
Private placements are a high-risk investment. An investment in such an offering is speculative and an investor could experience an entire loss of principal. Private investments are highly illiquid and risky and are not suitable for all investors. Investments in early-stage private companies should only be a part of your overall investment portfolio.
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What is an Angel Investor?
An angel investor is an individual person who invests his or her own money into early-stage startups. Angel Investors can be lone operators, or they can be a part of a larger group of like-minded individuals. Angel Investor can find investment opportunities through their own personal networks, through clubs and other private organizations, and through online investment platforms.
What is Angel Investing?
Angel Investing is the process of investing one’s own funds into startups for the purpose of financial gain.
Who can be an Angel Investor?
Anyone who meets the regulatory requirements and can sustain the potential risks can be an angel investor.
In the US, private companies can raise funds from outside investors through different regulatory allowances dictated by the Securities and Exchange Commission. Most startups raise funds through the 506(b) exemption, which allows them to raise an unlimited amount of money from accredited investors.
Can You Get Rich by Angel Investing?
The short answer is “Yes, but…” by definition most angel investors get rich before they start angel investing, and then invest in startups as part of a larger strategy to multiply their wealth.
As previously noted, most accredited investors qualify as such because they are high-net-worth-individuals, high-earners, or both. According to US Census data, households with annual income over $200,000 represent the top decile of earners in 2021. (US Census, “Income and Poverty in the United States: 2020” p.36).
Angel Investing is therefore a tool to multiply wealth by investing in innovation, not a tool to achieve wealth in the first place. It should be noted that not everyone who is an Angel Investor is successful, and that there are a number of unique risks in angel investing that can result in the total loss of invested capital.
The internet provides numerous examples of rich angel investors, and there are without a doubt people who have amassed wealth by investing their own money into startups. Investing in alternative assets is considered to be an aggressive strategy, that is by definition high-risk, meaning it has a high variance of potential returns.
There is no comprehensive public data on angel investing returns, but angel investors invest alongside venture capital funds, and the distribution of fund returns can serve as a useful benchmark for angel investing.
It is important to remember that top Venture Capital investors usually work full time as professional investors whereas most most angel investors do not work as full time investors. Comparisons between VCs and Angels are not apple to apple comparisons, and angel investors should not expect their returns to match those of top performing VCs.
Cambridge Associates, a firm that aggregates investment data, reports that their proprietary index of VC investors gained 31.1% during half of 2021, as opposed to 14.71% on the S&P 500 for that same time period. Past performance is not a guarantee of future performance and market conditions can change dramatically over time.
“With double-digit returns in each of the first two quarters of 2021, the US venture capital index has now posted four such quarters in a row for the first time since the late 1990s.”
— Cambridge Associates US PE/VC Benchmark Commentary: First Half 2021
Past performance is not a guarantee of future performance.
How Does Angel Investing Work?
If you’re new to angel investing, Swati Chaturvedi and I recorded a podcast episode on Getting Started in Angel Investing that is a great 14 minute primer.
- Set an allocation
- Build a quality deal flow pipeline
- Build a portfolio
- Hold On
1. Set an Allocation
An allocation is an amount of money set aside by an investor to invest in a given opportunity or asset class. Startups are considered alternative investments – meaning they are private market transactions that are illiquid and are usually not 100% correlated with the public markets.
Before an individual starts investing, best practices suggest setting goals beforehand to be able to measure performance.
A 2004 memo “Asset Allocation and Portfolio Strategy for Angel Investors” written by William (“Bill”) Payne for the Angel Capital Association and the Kauffman Association outlined three portfolio allocations of 10%, 15%, and 20% of an individual’s overall net worth allocated to angel investing. A recent 2021 Ernst & Young India Private Market Report focused on Ultra-High-Net-Worth-Individuals (UHNWI) found that 83% have an allocation to private markets of 10% or more.
An individual could target an allocation of 2% of their net-worth to be invested in startups five consecutive years to achieve a 5% allocation. Startup investments typically follow a J-Curve, where the failures precede the successes, so spreading out an allocation over a number of years is a good way to maintain investment discipline.
2. Build a Quality Deal Flow Pipeline
There’s an old saying, “You have to kiss a lot of frogs before you meet a Prince,” which means that in order to find something of value, you have to spend time looking through a lot of things that are not valuable.
Angel investors gather and review scores of investment opportunities – potentially hundreds in a given year – by developing extensive networks and joining angel investing platforms like Propel(x).
Investing platforms are a nice point of entry into building deal flow because they are often free to join and some of them do a good job of comprehensively packaging investment opportunities. Moreover, companies like Propel(x) provide end-to-end services so all the deal closing tasks are wrapped up in a neat package that is much more efficient and typically more organized than going alone.
The key to building a good pipeline is to use trusted vetted sources to find opportunities, and to use your own acumen and your own network to review and form opinions about which opportunities could be good investments and which you’ll decline. You should always do your own due diligence, before investing in any opportunity.
3. Build an Angel Investing Portfolio
In theory, a good well-balanced portfolio will provide a lower risk than a single investment or concentrated portfolio. Startup investments can potentially compliment a diverse basket of public market investments because they are less correlated with public markets – a drop or rise in stocks doesn’t immediately impact the price of stock for a startup.
In broad terms, investors look to expand their efficient frontier – that balance of risk and return to maximize the latter and minimize the former as measured by the internal rate of return.
“If you look at the distribution of outcomes in a venture fund, you will see that it is a classic power law curve, with the best investment in each fund towering over the rest, followed by a few other strong investments, followed by a few other decent ones, and then a long tail of investments that don’t move the needle for the VC fund.”
– Fred Wilson (Union Square Ventures), “The Power Law and the Long Tail,” AVC
A diversified startup portfolio usually includes a minimum of 10-15 startup investments.
4. Hold On
Angel investing is a long-term strategy for wealth accumulation. It takes years for a startup to grow and become stable enough to warrant a profitable exit. Angel investors should expect their investments to take three to ten years to provide a return, with the knowledge that most angel investments will not provide any returns whatsoever.
Summary
- Set aside two to fifteen percent of your overall net worth to allocate to angel investing
- Build you access to good opportunities by going through trusted sources, such as transparent and well-governed investment platforms and known personal networks
- Review many deals, invest in few
- Allow time for the investments to mature.
Private placements are illiquid and there is no guarantee that an exit strategy will come to pass. You may not ever be able to sell or liquidate the investment or to receive a return of principal.
What is the difference between a Venture Capital (VC) Fund and an Angel Investor?
1. Source of Funds
- Venture Capitalists invest other people’s money through a General Partner / Limited Partner Fund
- Angel Investors invest their own money
2. Investment Amount
- Venture Capital Funds range in size from the millions to billions; they have more money to deploy and write larger checks into the hundreds of millions per deal
- Individual Angel Investors typically invest between $5,000 and $250,000 per deal.
3. Non-Financial Resources
- VC Funds often have a full operational support team that helps their portfolio companies with hiring, sales, accounting, and everything in between.
- Angel Investors often look for non-financial means to support their companies but are limited to their personal network.
4. Portfolio Concentration
- Venture Capital Funds typically make one investment per sector as to avoid internal competition within their portfolio.
- Angel Investors can invest in the same sector repeatedly. Many successful business angels invest exclusively in one or two sectors where they have domain expertise.
5. Investment Life & Duration
- Venture Capital funds last 5-10 years. If they don’t produce above average returns, the investors in the fund may not provide the VC with any further money and as a result the VCs lose their jobs.
- Angel Investors invest their own capital and can afford losses (and get potential rewards) without quitting the industry. The investment period for a successful angel investor might be thirty years long.
If you’re curious about venture capital, you can read our article What is Venture Capital?
Tips from Thirty-Five experienced Angel Investors
In 2017, the Propel(x) marketing team surveyed our users to ask the following question:
“Do you have any tips for fellow angel investors to keep in mind when investing?”
Advice on Angel Investing (Summary)
- Get Help
- Focus on the People
- Do Your Research
- Focus on Your Exit Strategy
- Diversify
- Keep Ego Out of It
- Treat It Like an Investment
- Be Mindful of Regulatory Quirks
- Help If You Can. Just Not Too Much.
- Develop Your Own Investment Framework
- Sometimes Timing is Everything
Please Note: Testimonials may not be representative of the experience of other customers and is no guarantee of future performance or success. Some of these investors may also be invested in Propel(x).
“Co-invest with another angel who has more investment experience.”
“Join some kind of angel group so you can invest and learn alongside others. I learned a ton from more experienced angels as I was starting out, and having access to them for advice or to ask that ‘stupid question’ accelerated both my learning and my confidence.”
“You can assume that the lead investor did some diligence on the company, but you should do some diligence on the lead investor.”
“Invest alongside experienced friends and groups you like and trust and whose sector interests are similar to yours. After some time doing this you\’ll be better able to operate more confidently.”
Anonymous Angel Investor
“Collaborate early and often with more experienced investors of angel groups.”
Timothy Lipton Momentum Finance
“Startupland is all about the founder, similar to how real estate is all about the location. Prior to Series A, the challenge is around the ability to find a modicum of product/market fit and expanding that connection – deepening and broadening that connection. Has the founder demonstrated financial maturity before there is real money at stake? Did the founder show respect (appropriate reporting) for the money that she, friends and family, and seed investors contributed?”
“Understand if the management team has the right ingredients to succeed. Proven abilities, not just good intentions, to: 1. Precisely define the specific use-case based on their specific first-hand knowledge of the problem, and not just their hypothesis of the problem; 2. Execute on the product design without major unforced errors; 3. Explain in detail the specific Go-To-Market (GTM) plan including a named partner who already has the channels into the market (It is really hard to break into a new market if you have to create your own channel); 4. Convince established institutional investors to eventually invest (VCs will want fast scale-up and large Total Available Market and a clear GTM plan.); 5. Be prepared to give up ownership and control in order to bring in the talent and investors to scale up (no mom-and-pop shop mentality).”
“It is important to realize that you are primarily investing in people, rather than ideas. A great idea is nice, but great ideas are out there in abundance. Without the people behind it who have the integrity, experience, and expertise to translate their ideas into a viable business, I would not be comfortable investing. There will inevitably be unforeseen challenges, and you need personnel who can navigate these and transform their businesses to accommodate them. Second, it is important to go beyond the business concept and understand the go-to-market strategy that will make this concept profitable. Without a clear and well-developed strategy, you are investing on blind faith.”
Jiazi Guo Tsing Yuan Ventures
“Make sure the management team has related experience and/or has a seasoned board of directors and advisory board, ideally with some grey hair. Disregard brand names (think Henry Kissinger on Theranos\’ Board) unless they bring scientific understanding and real-time operating experience to the table.”
“At the start of an investment process, it is about the deal. At the decision to invest, it is about the Founder.”
“It’s all about the people. Do you have high confidence in the team?”
Anonymous Angel Investor
“The most important feature of an investment opportunity is the CEO of the startup: how experienced they are and how well they communicate with you.”
Anonymous Angel Investor
“Really assess the company’s people and don’t expect a quick payoff.”
Anonymous Angel investor
“Angel investing is not unlike dating. Accept that most deals won’t be a fit.”
Anonymous Angel investor
“The old adage of ‘back the jockey, not the horse’ is important, but is only part of the picture. You have to believe in the business model and product concept because even Bill Shoemaker loses on a donkey.”
“You really have to do your research, especially because information is limited for private, early-stage companies. Platforms like Propel(x) are great because they do a lot of the legwork for you. But you still need to reach out to your personal and professional contacts for perspectives, research the market and competitive landscape, talk to potential customers, etc.”
“Make sure that early-stage companies have sufficient capital to complete product and service development. Development runways are often longer than projected by founders.”
“Go slow. Evaluate many companies before you decide which ones to invest dollars in. Start by investing time. You may benefit just as much if not more than the entrepreneur.”
“If you like every deal you see, you’re not seeing enough deals. See as many deals as you can be presented in your chosen area. Go to pitch events, watch deals online, read pitch decks to help you calibrate quality and concepts.”
“Most new angels focus on the wrong things. They get all tied up in the story and the idea or the passion of the entrepreneurs. There is really only one thing that angels should evaluate in looking at a company and that is its exit strategy. This is basically the answer to the question, “how am I going to get my money back?” Not only is this important, but it is also one of the more fun questions to answer. It involves deep industry understanding to see where the incumbents have gaps and how the company can fill it. Of course, the answer will involve all the regular things you thought angels should ask – Team, market, product, competition, IP, barriers, risks, finances, deal structure, etc.”
“The number one thing I wish I knew when I started angel investing is to consider doubling down on the companies that are doing well. In order to do this, you need to reserve some extra cash to invest your “pro rata” in a company’s next round. This allows you to maintain your percentage ownership. For example, if you invest $25,000 at a $2.5 million valuation, you’ll own 1% of the company. If the company’s next round is valued at $10 million, you’ll want to invest enough to maintain your 1 percent ownership.”
“Focus on a well-balanced portfolio of at least 2 dozen high-quality early-stage investments; recognize it is better to diversify your early-stage investment than it is to do follow-on investments”
“Diversify. Spread your capital available for angel funding into 20-50 individual investments. Even successful VCs with their careful due diligence end up with 1 home run out of 10, 2-3 walking deads, and 6-7 write-offs.”
“If your goals are primarily monetary, individual angel investments are not efficient unless you invest enough to achieve adequate diversification. An alternative is an angel fund, where you will likely trade off engagement for better return through scale.”
“Diversify early and limit single-company exposure until you’ve built up your bank account in this higher-risk investment category.”
“The number one thing I wish I knew when I started Angel investing was to really focus on making multiple investments instead of putting a large amount in a few companies. In the beginning, I “fell in love” with a few companies and backed them hard. The right way to invest is to spread the wealth and when you sense a company is turning the corner you invest more money in the next round. Strengthen your position in your winners and understand that companies are going to fold. Take the good with the bad and I believe in the end with a little luck you’ll come out way ahead.”
Anonymous Angel Investor
“Don’t put all your eggs in one basket.”
Anonymous Angel Investor
“It is impossible to pick winners in early-stage investing. Most (>50%) will fail in spite of how good they look at the time of the investing decision. Accordingly, don”t fall in love with any one company. Spread your money around a number of companies.”
Bernard Lupien Rhapsody VP
“It’s fun to be popular. What I mean is that when you have money to invest, everyone wants to be your friend. You might think it’s because of your charismatic personality or because of your dashing good looks, but really it’s because raising early stage money for a deep tech startup is hard. Don’t get caught in the popularity trap.”
“Play from your strengths. Don’t try to copy or compete on turf that’s foreign to you. Deep knowledge and understanding of a particular field is worth a lot. With respect to investing in an area not in one’s area of expertise, ask the right questions and look at who else is interested, expertise, and responses. Self-knowledge and humility – but with conviction – can go a long way.”
“Companies want your money, not your advice. Few angels get board seats— lead investor perhaps. Your highest level of engagement will likely be due diligence.”
“I was surprised to learn about alternative avenues for investing in startups, for example, through IRA’s. For many people, their retirement account may be their largest source of investable capital. Being able to invest through IRA’s gave me additional flexibility and the opportunity to further diversify my retirement portfolio (not to mention the tax advantages).”
“Companies want your money, not your advice. Few angels get board seats— lead investor perhaps. Your highest level of engagement will likely be due diligence.”
Anonymous Angel Investor
“Treat your angel investments as an asset class. Decide on an aggregate amount, divide by 25+/-, and that’s what you invest in each round. You’ll fall in love, and others may inspire you to do more, but stay disciplined. Odds are against you in each deal.”
Anonymous Angel Investor
“Define what your risk appetite is. How much are you willing to invest per year?”
“I started angel investing in Australia, before moving to Silicon Valley and the regulatory differences between countries has a few little quirks I wish I’d known more about. Particularly how your rights and responsibilities change over time and additional investment rounds. But of course, you always learn more as you go.”
Anonymous Angel Investor
“If you’re investing in an area that you have knowledge and relationships with, you have an opportunity to increase the chances of success by being of value but please be mindful not to get in the way.”
“Invest in categories you know and where you can help entrepreneurs maximize their chances of success.”
Bernard Lupien Rhapsody VP
“Find opportunities and companies where either contractually or through massive alignment, you can meaningfully contribute to the startups’ success. That means more than just being on the Board. Otherwise, you are just along for the ride, and as an early-stage investor, that’s a proposition that you will find unrewarding unless you get lucky!”
“Be sure to spend time thinking about and developing your own investment thesis — the why, what and how of your personal angel portfolio. This will help to gate your decisions and take out at least some of the emotion. Buckle up — it’s an interesting ride!”
“Have your own view; don’t follow what other people are investing in and don’t just focus on the hot market. Invest with your own view and always track the lessons that you learned over time. You may not always right, but make sure you learn from mistakes.”
Gopi Rangan Sure Ventures
“Invest in a startup which will help you learn. This is against the traditional view of investing in what you know. Angel investing is as much about discovering your own passions as much as enabling a founder’s dream. Angel investing is a great way to stimulate intellectual thinking. The more excited you are about learning a new product or an industry, the more valuable you will become as an investor to your portfolio company.”
Anonymous Angel Investor
“Take time to develop and understand your investing thesis. Platforms like Propel(x) do an outstanding job of generating deal flow and it can be overwhelming to sort through the various opportunities. Having an investment thesis to guide makes a big difference.”
Anonymous Angel Investor
“Understand that the odds are against you, even if you’ve done your diligence on technology, business, team, financial projects, strategic fit, sometimes the timing isn’t aligned with the universe.”
Want to start your own investment journey?
The Propel(x) platform makes it easy to find new companies, evaluate many companies and shop for investment opportunities. We have the tools you need to make informed decisions and discover fascinating technologies, industries, and innovations. If you\’re new to the process, you can learn more with our angel investing guides.
Information discussed here is not intended to be nor should it be construed or used as investment advice, a recommendation, or an offer to sell, or a solicitation of an offer to buy securities. Any offer or solicitation of an offer to buy security can be made only through official offering documents that contain important information about risks, fees, and expenses. Private investments are highly illiquid and risky and not suitable for all investors.
