Angel investing can be fun, exciting, but also very risky…
For many, angel investing can be an exciting next step in their career. Some investors enjoy being directly involved with companies that are at the fore-front of innovation. Others like the thrill and buzz that comes with tech startups whilst being able to diversify their investment portfolio and benefit from tax incentives (e.g. EIS or SEIS). Angel investing is nonetheless challenging, especially if you’ve never done it before. Ideally, you’d want to be good at angel investing and also be of added value to the startups you invest in — some effort beyond the initial bank transfer is usually needed to make things a success. What makes for a good angel investor and how to become one are some of the aspects we will touch on in this article!
Angel Investing: What is it and how does it work?
An angel investor is an individual that typically invests in the early stages of a new venture in exchange for equity. The startup can be at the idea stage, have a (working) prototype, an MVP and/or some initial market success. Angels are very different from a bank or venture capital fund as they invest their own capital and tend to get involved very early-on (pre-product, prototype etc.). While some may believe it to be so, an angel does not have to be a high net-worth individual with several millions to invest. Someone who has built a long career in the banking sector for example could choose to become an angel and leverage their experience, knowledge and network to invest in fintech startups. Investing for an angel can be done to develop multiple streams of (future) income but it can also be to delve deeper into a specific vertical or to diversify an investment portfolio with high-risk/return allocations.
Angel investors tend to be one of the most important seed investors for getting the idea off the ground. Angels are usually sought after by startup founders due to their guidance, network, experience, knowledge and overall risk appetite for venturing. While angel investors can be accredited investors, it is not a must. Some angels invest exclusively on an individual basis (building their own dealflow, conducting due diligence etc.) and others invest as a group of angels. While neither option is bad, anyone wanting to start out with angel investing ought to make a careful consideration of the options available.
Angels are also sparring partners for startup founders.
So what’s in it for the investor? Angel investors make a return on their investment by exiting the venture at a later stage. They can also be “bought out” by a new investor (e.g. a vc fund) or by the startup founders themselves. While angels typically invest early in exchange for a favourable equity position, investors can also opt for a (convertible) loan (i.e. debt that converts into equity) or a revenue-based return which is more founder-friendly, provides liquidity and is more aligned with the success of the venture.
The main differentiator between an angel investor and a bank or venture capital fund is that angels invest their own personal capital while a fund typically invests capital from its own investors (i.e. limited partners). Angels also tend to participate in smaller rounds, with ticket sizes being relatively small (under EUR 1M). Furthermore, angels generally have a limited capability for follow-on rounds, meaning that they might only be able to invest in two or three funding rounds due to risk diversification or a limit of available capital. Nonetheless, angel investors are highly sought-after by startup founders as they tend to be very knowledgeable in a specific market or vertical and have a lot of experience. Some investors were former entrepreneurs themselves and are able to provide valuable insight and guidance to founders.
Becoming an Angel
Making the decision to become an angel investor requires a personal consideration and weighing the pros and cons. In principle, once you’ve made your first startup investment you have pretty much become an angel investor. Let’s take a closer look at some key aspects of the work behind an angel investor:
Capital
Investing in startups can be done by committing capital from 10k up to the millions. It all depends on your capital available, portfolio strategy and risk appetite. Being able to invest in follow-on rounds is also an important factor to consider. For angel investors starting out it is good to realize that angel investing is a long-term game. Capital invested is usually used by the startup for R&D, prototyping, hiring staff and testing the market. As such it is tied into the success of the venture, making it an illiquid asset class generally speaking.
Building Dealflow
Angel investors tend to have a network and constant inflow of new opportunities and deals coming in. Building a pipeline of potential investments will be one of the first tasks for a new angel investor. Consider making accounts on industry/startup platforms, launch a website, write blog articles, join an angel group, attend meetups and other startup events and reach out to founders you come across to start “getting our name out there”.
Pitch Meetings
Many founders will request meetings with angel investors in order to pitch them their idea and why their startup is a good investment. Choosing which meetings to take on and which questions to ask during such meetings can make a big difference in terms of time invested. It’s usually a good idea to request a pitch deck before moving forward to an introductory meeting. This gives the investor a quick glimpse of the startup, its team, product, market and overall traction. While angel investors invest in early-stage venture ideas, they are usually focused on the team behind the idea, the founder in particular. An initial startup idea with potential is not worth much if the founder behind said idea is unable to develop the idea and create a successful business. As any sound investor would do, an analysis of the business model, the market, the financials etc. all weigh in the final decision an angel investor makes. As such it is key for founders raising their first funding round to devise a strategy to pitch to investors and convince them why they are the right team for bringing a new innovative product to the market. The quality of the team, resourcefulness of the founder, talent and ability to take constructive feedback are some of the key aspects that angel investors look for.
In fact, when meeting angel investors and pitching them, founders ought to try and get a feel for their background, potential added-value to the venture (smart money) and investment interests. As much as a founder is pitching an idea to an investor, it is also important for the founder to have the right investors on the cap table and gain the proper support needed to turn the startup into a success.
Investment Decisions
Conducting proper due diligence and negotiating the terms of investment with startup founders will also be part of the work involved. There are many aspects that are relevant for a good term sheet such as the valuation, investor rights, provisions etc. However, it all boils down to your own preferences as an investor and what you are able to negotiate with the startup. Ultimately, making the decision to invest in a startup is going to be one of the most challenging aspects of angel investing. Deciding on the right team to invest in, the right idea that you think will work — all of this requires good judgement on behalf of the investor. Once a decision is made, it is good to review any investment agreements provided and seek legal counselling whereas needed.
Closing Thoughts: Angel Investing is Risky
Investing in early-stage startups is a long-run and risky endeavour, hence there is no need to rush things. While many success stories can be found everywhere nowadays, it’s good to know that early-stage ventures carry a high risk with them. It takes a lot of sweat equity to take an idea off the ground and turning it into a success business that can generate a decent return. Hence, it is advisable for new angel investors to ease into things and gain their own experience step by step. Being excited about new technologies and startups is a great motivation, but investment experience can be the difference in success or failure as an angel investor. In some cases, a startup only manages to build a rough MVP or small client base without achieving product-market fit, the founder might not be on the same page with you anymore somewhere down the line, product pivots occur, you can forget a key investor term in a term sheet, the dynamics of new investors change the relationship with the founder — all of these experiences can help one become a better investor over time. As such investing small tickets (e.g. under 100k) in a range of initial startups is a good way to gauge your own performance as an investor, learn from mistakes whilst taking a lower financial risk and developing your own investing strategy. In fact, it is a good portfolio strategy to consider as spreading risk, diversifying startup investments and investing smaller tickets can help in finding that one unicorn that makes the big difference in terms of returns. Being more reserved in the first funding round and investing more in follow-on rounds is also an approach that can help mitigate risks further and only focus on those startups that are making good tangible progress.
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