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Angel investing involves high net-worth individuals injecting funds, often coupled with their time, into early-stage businesses to facilitate their growth. In exchange for their financial support, these investors acquire a modest equity stake in the startup, entitling them to a specific percentage of ownership. The underlying expectation is that the invested company will prosper, leading to a substantial appreciation of the angel investor's share in its value.
The allure of angel investing gained momentum with the success stories of early backers profiting significantly from renowned companies like Uber, WhatsApp, and Facebook. Even today, these investors stand to reap rewards as the companies continue to thrive. Notably, the graphic below illustrates some notable exits involving unicorn startups associated with prominent venture firms.
Source CB Insights
However, it's crucial to recognize that such lucrative outcomes are exceptions rather than the norm. Many angel investors face the unfortunate reality of financial losses. In essence, angel investing constitutes a partnership between the investor and the startup, aligning their financial fates. If the startup flourishes, the angel investor reaps the benefits. Conversely, if the startup falters, the angel investor incurs losses.
Typically, angel investors are individuals with disposable capital seeking higher returns than traditional stock market investments. These investors may include family and friends supporting the startup, professionals like doctors and lawyers, business executives with experience in managing large companies, entrepreneurs who have previously launched their startups, professional angels deriving their livelihood from angel investing, angel syndicates collaborating on investment deals, and crowd funders pooling funds from a large number of small investors.
What is the Typical Investment Range for Angel Investors?
Angel investors play a crucial role in supporting companies during their early stages by providing modest financial backing. This support becomes particularly valuable when startups face challenges attracting interest from venture capital firms. Typically, venture capital firms become interested only after the startup has utilized the angel investors' funds and demonstrated some growth. The amount invested by angels varies widely, influenced by the startup's appeal and its growth requirements. Individual investments commonly range from $5,000 to $150,000, with a typical angel investment round amounting to $100,000 to $250,000, sourced from a group of 3-5 investors. In rare instances, angel investments may reach as high as $1 million. Larger funding amounts are typically secured through angel groups and syndicates, where investors pool their financial resources and business expertise. Platforms like A2D accept minimum check sizes of $3,000.
What returns do angel investors receive on their investments? The typical range for startup valuations that attract angel investment falls between $1 million and $4 million. Startups valued higher than this range are more likely to attract venture capital.
However, it's crucial to note that the valuation of the startup isn't the primary determinant of an angel investor's returns. The focus is not on choosing a $2 million startup over a $1 million one, but rather on the success of the invested company. Angel investors realize profits when the startups they invest in thrive.
Therefore, during the investment process, fixating on deal terms may not be as critical as evaluating the potential for the business to grow and achieve success. Angel investors are advised not to seek controlling interests or majority stakes in the startups they support. Founders need to retain a significant ownership share, typically around 20-25%, to ensure their continued commitment to growing the business.
What Phases of Business Do Angel Investors Typically Support?
Angel investors typically engage with companies in their early stages. This could occur when the enterprise is merely a conceptual idea or during the initial stages of marketing and selling its product or service.
During this phase, it's uncommon for startups to have a substantial customer base or significant revenue. They might attract beta customers, and early adopters, or generate some market interest.
Angels typically serve as the initial investors after the founders' initial capital injection, playing a crucial role in the company's growth. This becomes particularly important when the initial capital is depleted, and larger institutional venture capitalists (VCs) are not yet inclined to invest.
How does the Investment Process Function?
The established process of angel investment, though proven, can incur substantial legal costs, and numerous deals may unravel during the legal negotiation phase. Nevertheless, here are the typical negotiation steps between a company and an angel investor:
1. Establish Deal Flow:
The initial step involves identifying potential opportunities and deals. While it is preferable to operate within a syndicate, creating your deal flow is feasible with a robust industry profile.
2. Screening the Deals:
As deals start flowing in, a careful screening process is essential to identify those aligning with your investment and risk preferences. Finding opportunities with low risk and high reward may seem akin to locating a needle in a haystack, requiring the evaluation of numerous pitches, investor decks, and thorough research.
3. Due Diligence:
For selected deals, conducting in-depth research and fact-checking is necessary to verify the accuracy of the information provided by the founders.
4. Agree on a Term Sheet:
Following due diligence, the next step is reaching an agreement on a term sheet with the startup. This document should cover deal economics, investor rights/protection, governance, management, control, and exit/liquidity considerations. Read more about term sheets here.
5. Raise the Money:
Depending on the situation, raising funds could be challenging. Individual investors may find it straightforward, while syndicate members need the support of others.
6. Finalize the Legal Documents:
The term sheet serves as a guide for the final legal agreement. Since various aspects of a term sheet are open to interpretation, the legal document delves into greater detail and is typically lengthier.
7. Closing the Deal:
The final step involves defining a closing date and process. Legal documents are sent for signatures, and funds are released. Upon completion of the closing process, the deal becomes legally binding.
Finally, after the initial investment, investors may choose to participate in follow-on investment rounds to maintain a substantial shareholding if the company experiences growth and financial success.
What Role Does an Angel Investor Play in a Startup?
There are no strict guidelines governing the involvement of angel investors with the companies they support. Nevertheless, it is in the investor's best interest to ensure the success of their investment. Consequently, they typically engage actively with the startup, especially during its early phases.
For individuals contemplating angel investing, it is crucial to establish clear agreements with the startup regarding the extent of involvement and the specific contributions the investor will make. The primary functions undertaken by angel investors encompass:
1. Source of Capital: While investing funds is a fundamental role, merely providing capital without additional engagement is not advisable, although it occasionally occurs.
2. Advisor: Collaborating informally with the founding team, an angel investor offers valuable business advice, stress-tests products, and propositions, and provides a supportive presence. Essentially, they contribute an external perspective and fresh insights.
3. Networker: Leveraging their connections, angel investors can assist startups in acquiring customers. Many professional investors boast extensive networks and familiarity with profiles in their respective industries.
4. Recruiter: Recognizing the challenges of rapid growth, investors often expedite the hiring process by referring individuals they have previously worked with, addressing a critical bottleneck to progress.
5. PR and Marketing Buzz: Recognizing that many startups struggle with marketing, some angels utilize their platforms to generate buzz, offering a cost-effective means of attracting early interest.
6. Technical Expert: Angel investors with relevant experience can provide assurance, guidance, or expertise in the startup's product development.
7. Board Member: Given the pivotal role in making crucial company decisions, such as fundraising, acquisitions, and senior management decisions, serving on the board is a significant responsibility for angel investors, capable of profoundly impacting the company's trajectory.
What Are the Advantages of Engaging in Angel Investing?
1. Asset Diversification: Angel investing facilitates diversification into a high-risk, high-reward asset class.
2. Professional Variety: Collaborating with a diverse array of startups proves intellectually stimulating, offering a departure from the routine of a day job and fostering the development of new skills.
3. Entrepreneurial Community: Engagement with startups and their founders opens doors to a supportive ecosystem and camaraderie rarely found in the corporate world.
4. Networking Opportunities: Angel investing provides access to a broad network encompassing founders, investors, partners, lawyers, and a thriving tech community.
5. Monetizing Expertise: Founders may seek your assistance and advice, particularly if you possess relevant skills, potentially leading to more angel deals or paid consulting opportunities.
6. Startup Education: Participation in angel investing offers insights into the challenges and triumphs of running a startup, providing invaluable lessons and education not purchasable with money.
7. Stay Informed About Trends: Involvement with startups ensures staying abreast of the latest trends and technologies. This engagement prompts research and learning about emerging markets and businesses, keeping the mind active.
8. Huge Potential Returns: Successful backing of a winning startup presents a substantial financial upside, allowing for potential doubling down and a rewarding exit.
What Are the Drawbacks of Angel Investing?
Despite the aforementioned advantages, there are notable downsides and risks associated with this form of investment:
Potential for Significant Losses: The majority of angel investments may not yield returns, and in the event of failure, the invested capital could swiftly become worthless. Hence, it is advisable to allocate only a small portion of one's wealth to angel investing.
Extended Return Periods: Due to the limited liquidity in angel investing, realizing cash returns from successful investments can take several years. This type of investing requires a long-term perspective, as it is not a quick way to accumulate wealth.
Navigating the Unknown: Decision-making in angel investing relies more on judgment than on in-depth analysis and evidence. The information and certainty available at this stage are minimal, making it unsuitable for those averse to uncertainty.
Is Profit Attainable through Angel Investing?
The probability of the business you invest in reaching a valuation of $1 billion stands at a mere 0.00067%. When coupled with the stark reality that 90% of startups meet failure, the prospect of making money through investing seems dubious. The predominant risk lies in the total loss of the invested capital if an investment falters, distinguishing it from partial losses in other scenarios.
Even investments that don't outright fail may languish in a perpetual state of dependence, requiring continuous financial bailouts—a condition commonly referred to as a "zombie" state. Such investments rarely achieve substantial growth, precluding any opportunity for profitable returns.
"Itai Damti wisely advises, 'Assume you'll lose everything in angel investing. Because you probably will.'"
Now, on a slightly positive note, for the fortunate few who choose a successful venture, the gains from these victories may compensate for the losses incurred elsewhere. Notable instances include early investors in Google, enjoying a return exceeding 1000 times their initial investment, and early investors in eBay witnessing an astounding 1500-fold return. These exceptional cases underscore the potential rewards of angel investing, where even a modest investment could yield substantial returns if the venture achieves remarkable success.
Consider a hypothetical scenario: investing $20,000 in an early-stage startup valued at $2 million. With a competent founding team that executes successfully, let's assume the company is sold for $40 million, avoiding dilution from subsequent venture capital investments. In this scenario, your $20,000 investment would be valued at $250,000—a tenfold return on the initial capital.
While this example comes with numerous caveats, it illustrates the possibility of substantial returns for those fortunate enough to identify successful ventures. It's crucial to bear in mind that actual gains materialize only during a liquidity event, providing shareholders the opportunity to convert their tied-up shares and assets into tangible cash.
Angel investing and startup exits encompass various forms of liquidity events. The primary methods include:
1. Initial Public Offering (IPO): Following an IPO, the company's shares become accessible to the public for purchase and trading. This stage provides an opportunity for founders and shareholders to sell their shares, realizing returns on their initial investments.
2. Merger & Acquisition (M&A): Another avenue for capitalizing on investments involves selling the entire company or selling a stake to an interested party, rather than opting for a public offering. Examples include acquisitions or mergers, where a shareholder sells their portion of the company to another business.
Summary
This article has provided insights into the realm of angel investing, distinguishing it from venture capital and outlining expectations for aspiring angel investors. In summary:
Angel investors, typically high-net-worth individuals, inject capital into early-stage startups, with investments ranging from $5,000 to $150,000, securing a stake in the company. Platforms like A2D accept minimum check sizes of $3,000.
The success of the startup translates to a lucrative return for the angel investor, while failure may result in a complete loss of the investment. Some angel investors maintain a hands-on approach with their investment, actively participating in the startup's development.
In comparison to venture capital and stock market investments, angel investing carries a higher risk. Investors must await a liquidity event to convert their ownership stake into cash.
To conclude, the article concludes by outlining the steps one can take to embark on the journey of becoming an angel investor. Begin your angel investing journey here!
A2D is Southeast Asia's fastest-growing angel investing syndicate platform where investors meet tomorrow's game-changing startups.
Our mission is – to be the region's leading early-stage investing platform and angel syndicate, dedicated to:
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