Angel Investors

Angel Investors: Who They Are and How Angel Investing Works

Why are they called “angel” investors?

The term “angel investor” has an interesting history. Broadway production would often be financed by wealthy theater enthusiasts rather than lenders. These investors would only get paid if the play was a success. These investors would be called angels because they helped save productions that would have died without their support. 

What is an angel investor?

Similar to the Broadway angels, angel investors in the business are individuals who provide initial funding or seed money to get the business off the ground. Usually, these investors fund the idea because they like it, expecting returns only once the business is successful. This is generally in the form of ownership equity in the company and/or to be part of the board of directors. 

Angel investors are usually wealthy individuals or even friends or family members who believe the business will succeed. Many may have been entrepreneurs themselves. Some may even be limited liability companies (LLCs).

How involved are they in the business?

Angel investment is one of the riskiest types of investments because there is no guarantee of success. The involvement of the investor in the business decisions of the startup they choose to fund varies. Some may just provide the initial seed fund or may be involved periodically until they reach a certain level of success, such as the launch of their product into the market. However, most angel investors limit their involvement to 10% of their portfolios, as they are aware of the high risk involved.

How do angel investors decide whom to fund?

Investors may meet entrepreneurs at various places, including business conventions, personal contacts, business referrals, and online business forums. Once they like an idea, the investor talks with the entrepreneur(s) about the idea, business plan, and the way forward with funding: investment amount, equity percentages, how much control the investor will have, as well as an exit strategy. The contract is then drawn up and the funds are released. 

Angel investors are careful to protect their funds from being completely lost through a few options. Because of the risk involved in the funding, many angel investors look for concrete exit strategies before deciding to move forward with funding. Angel investors are more likely to invest in a startup if there is an acquisition opportunity or if the startup has the potential to go public in the future. 

Pros and cons of angel investment

No new debt: Since most angel investment deals are based on equity, business owners do not apply for a new line of credit and don’t have to pay the angel investor back. However, equity deals can often be more expensive than loans if the investor needs compensation for their funding.

The investor may be an entrepreneur: This can be valuable for sharing business knowledge, experience, and strategies. And, since the person has been in the same position in the past, there may be more empathy as well. But this could also mean losing control of the company in case things don’t work out if the investor wants to be more involved in business decisions.

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