For an investor, there’s no greater thrill than getting behind a promising new business early on and helping to make it a success. Today, there are roughly 300,000 Americans who, as angel investors for startups, attempt to do just that. The amount of active angel investors in the United States continues to grow. The Small Business Administration (SBA) estimates that there are more than 300,000 individual angel investors and growing fast in the United States in 2019, which provides funding for about 30,000 companies per year.
Entering the world of Angel Investing can be challenging and exciting at the same time. We have found that there are five identified different ways to invest. Each with different levels of risk-reward. Each investor will have to choose their preferred way to invest based on their personal needs, wants, or desires. It fundamentally a factor of:
- Level of Risk
- Available Capital
- Level of involvement
The fundamental difference is the investor position of the risk-tolerance level. Going from higher risk to a lower risk factor. Although the majority of angel investors invest informally, smart, and savvy investors typically choose an Angel group or Angel Fund.
The Fact in the Matter!
Regardless of which path you will take each investment opportunity will still have to go through the most common 10-steps of the investment process.
Option #1: – Individual & Informal Independent Investment
Success Rating – Very Low
Data indicated that the majority of Angel Investors invest informally. The type and style of investment approach for investors that prefer to be independent are based on the investors’ personality and mindset. This path will require a high level of work on behalf of the investor. The data sources we have collected indicate that the cost of the process for the deal size of $250K and up ranges between $10-20K (Hard and Soft cost) per deal. Independent investors in most cases will absorb 100% of the transaction cost, which is not a very economic way to leverage capital. Although for those investors that planning doing is a full time, might increase the success ratio. It is estimated that only 60% plus of the total Angel investors are doing it informally and independently on a part-time basis, despite the high-risk factor, which goes against business common sense. I guess that sense is not that common after all.
Option #2: – Online through accredited Funding Platforms
Success Rating – Low
There are many online platforms and more coming each day that are offering investment in startup companies from crowdfunding to online groups and syndications. Some are very good and highly credible and some are not.
As with any online platform, there is a level of risk from scammers, criminals, and people that use the internet to take advantage of innocent people, and there are plenty of them out there.
Most of them offer some basic level of support, yet the individual investor is one of many and most likely will not get the personal attention and deep level of support in the investment process. As with any online business model, there is a certain level of bias built-in such as luck and objectivity when it comes to promoting their own deals. The benefit of an online platform is that the entry-level is as low as $1,000 or even less. Although it sounds tempting, it is a drop in the bucket and the upside will not be substantial at best, if at all. There are some good opportunities in some online platforms, what we have learned is that many experienced investors use some online investment platforms, yet they start using them after they gain their investor prowess and experience first.
Option #3: – Accelerators & Incubators Association
Success Rating – Moderate
There are selected groups within the Angel Investor community that use their association with Startup Incubators and Accelerators to start their angel investment career. Independently runs incubators and accelerators, typically breeds new waves of angel investors that are coming from the pool of business professionals and advisors that work within the startup ecosystem and were introduced to various startup experiences. In the case of Incubators and Accelerators run by the universities’ commercialization offices, it creates more Angel Investors that are coming out of the university alumni business community that are connected to the university. Although conventional wisdom tends to think that because their association with a university means high quality of deals, it is not always the case to say the very least.
Option #4: – Angel Investor Groups
Success Rating – High
Most investor groups & syndication are much more organized and some are even more formalized with membership rules and formal structure as a legal entity. Most groups and syndication require membership fees – typically in a range of $1,000 to $2000 per year in addition the group will receive a 10% carry on the portfolio performance of the upside on the investment after the investor recoup their initial investment.
A significant number of the group operate a full-service backroom from deal flow management to a complete investment process management. They are effective and well organized, typically holding monthly meetings where they hear pitches from entrepreneurs in need of capital that are attended by the group members.
Though attending monthly or quarterly meetings might sound like a lot of work, there are some important reasons why the team approach is popular among angel investors. Within a group, you will most likely find investors with different disciplines, like operations, marketing, finance, R&D, etc., and even different industries like automotive, banking, real estate, life sciences, etc. These kinds of investors, in a group, help bring a lot of “brainpower” on evaluating companies and can even help the company afterward beyond the investment. A group made a decision that can help mitigate some risk. Most young companies are seeking more cash than any single investor is willing to put up—often upward of $1 million. By dividing that ownership stake among several investors, an individual may only need to kick in say $25,000 to $50,000 on a single deal.
\It allows the Investors to split the considerable due diligence work that any major investment requires and be a huge time-saver. A collaborative operation allows the funders to draw on each other’s experience and expertise. The decision to invest in a particular opportunity is still up to the individual investor to “Cherry Pick” their own deals, but in this way, prospective investors get input from others in the group before they decide whether to get involved, as they say: “Follow the money idiot”. One person can be wrong, ten people not so much. A group provides its members with “crowd wisdom”, which can be very powerful.
Perhaps the biggest advantage of joining a well-organized group, however, is being able to learn about more deals and more critically have full stack backroom support with all the necessary resources. Angel investing is by its nature a high-risk high-reward proposition. As such, most experts suggest having a portfolio of at least 12-16 companies in order to protect your capital. It certainly helps to have access to a steady flow of highly qualified and vetted deals – something that’s hard to achieve if you’re going solo with regard to angel investing.
Option #5: – Angel Investment Fund
Success Rating – Very High
The last option represents the more attractive form of investment and it is the lowest risk bracket of them all. There are a few reasons, the first is that all venture funds are regulated by the SEC and enforced by FINRA, and have a very formal structure: the investment decision and management, the accounting, and the audit of the books are being managed by three separate independent organizations to ensure the checks and balances. It is registered as a legal entity that is being managed by the Fund Managers that are supported by an assembled board of advisors. It is required to be registered and reported to the SEC and be audited on an annual basis. So in the risk factor spectrum, it is the lowest risk bracket, there is still a risk factor, yet it is much lower than the other options.
A fund has a typical structure of what is being known in the industry as the 2/20. The fund managers, which can also be another legal entity, are being paid 2% of the total capital under management for managing the fund’s investment activities and 20% carry on the fund performance. The fund management selects which companies receive funding and at what level. In most cases, the fund will not invest more than 5-10% of its capital in one deal. Some “dry power” is reserved for follow on funding should it be helpful and necessary. An average fund invests in 24-30 companies in the life of the fund which according to the Witbank model will ensure a 98% probability of 3.8X return on equity. Most angel funds outperform independent investing in the ratio of 5:1. It typically represents highly savvy investors that are involved in more than one track of investing and understand diversification and risk mitigation very well. Investors in most funds are “passive investors” meaning they do not select the companies nor participate in any way with the company. Some funds welcome participation with the portfolio companies and help match the investors with the appropriate companies.
The Bottom Line
If you’re new to angel investing, it often helps to join an angel fund or a group that can partner up on deals and spread out the due diligence work. In online syndicates, you don’t necessarily need to meet face-to-face with other members to get your crack at early-stage investment opportunities. Some investors participate in more than one of the options, you can allocate some capital to online investing, become a part of an angel group (sometimes more than one), and invest in an angel fund at the same time, many smart investors do.