How to become an angel investor
Angel investing can be a more personal way to invest, but it comes with big risks.
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If putting your money in an algorithm-driven index fund is too impersonal for you, angel investing is a way to put a face on your investments. Being an angel investor gives you a chance to invest in a company from the start in exchange for a stake in the business.
Startup founders go through several rounds of funding before getting a company off the ground. Their first round usually taps friends and family. Once that resource is dried up, founders may turn to angel investors.
Angel investors help companies reach a point where they can start attracting venture capital funds. Angel investors are individuals who use their own money to invest, whereas venture capital firms are much larger and use other people’s money for investments.
To be an angel investor, you must be an accredited investor with the Securities and Exchange Commission, make $200K annually, and have $1M in investable assets. President Barack Obama signed a law in 2012 allowing non-accredited investors to participate in angel investing using crowdfunding platforms, but accredited investors have the ability to risk more money to make bigger bets.
Angel investors contribute to a startup’s funding goal in exchange for a piece of the company. “My job is to get [a company] from first base to second base,” said Simon Hopkins, a board member of New York Angels, an angel investing group. “In order to do that, [founders] give up some percentage of ownership of that company for the money that we put on the table.”
Because you’re there at the early stages of a company, angel investing can be a more personal way to invest your money. However, these investments are risky and your money is tied up for a long time. Here’s what you need to know if you want to become an angel investor.
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Angel investors write checks to the tune of $25,000 to $50,000 to startups, said Hopkins. In return, investors may get equity and shares of the company or take on short-term debt that converts into equity down the road.
Angel investors’ goal is to invest in a company that is later bought out or goes public, which is rare, he said. Both scenarios have a 5 to 10 year horizon. “It's years before [you] see the return,” said Hopkins.
Angel investing is a long-term game, and very few of your investments are going to work out. Because startups don’t have to report their numbers publicly, there’s little hard data on how successful they are. New York Angels founder David S. Rose estimated, based on several independent studies of angel returns, that 50% of angel investments fail and 20% eventually return the original investment. The chances of earning profits are even slimmer. He estimates 9% of investments will return a profit of 10 times the investment and 1% return a profit of more than 20 times the investment.
“It’s the one outsize return that kind of pays for everything else,” said Hopkins.
Angel investors back startups in hopes the company will eventually be acquired or go public. Their money helps startups meet early round funding goals that hopefully attract the attention of venture capital funds to get even more money. Even if a company you invest in garners that kind of attention, it’s still a long-shot that the company makes it big or hits unicorn status, meaning it has a $1 billion valuation as a private company. According to new data from AngelList Venture, a venture-backed startup has a 2.5% chance of being a unicorn.
Making this type of investment is illiquid, meaning you won’t have access to that money for a while. Getting your full investment back in the future is slim and a big payout is even rarer, said Hopkins. “You shouldn't invest any money that you have better use for in the next 5 to 10 years,” he said. “That means you should only dedicate a small part of your portfolio to angel investing.”
Companies are eager for funding and often seek out angel investors, said Hopkins. Before the pandemic, most networking happened in person. Being part of an angel group like New York Angels can make networking easier, he said.
The New York Angels membership includes more than 130 investors. The group gets an average of 200 applications from companies a month, he said. The trick is finding the right one to invest in (Legal note: New York Angels is a non-profit membership group. Its members make investments on an individual basis. New York Angels does not make investments as an organization). Hopkins looks for a personal connection with founders and the potential for mentorship. He said communication is key for a healthy relationship with founders. “I like to stay close to the company so I can help, advise, and keep a handle on how they're doing.”
Before you cut your first check, make sure the founder and their team are realistic. Hopkins says a founder is as crucial as the team behind them. It’s important to ask the right questions in a pitch meeting, he added. He said you should ask yourself three things: Do you like the founders and their team? Do you like what their company is doing? Is there a market for it? It’s important to gauge how realistic the team is about their growth, projections, and competition. Hopkins said it’s a red flag if a startup is unrealistic about any of these aspects.
“There’s a personal side to being an angel investor,” said Hopkins. “When you’re investing your own money, it gives you a right to be slightly selective and a little bit selfish.”
Looking for a good founder story? Listen to Jen Fitzgerald’s journey to co-founding Policygenius on NPR’s podcast “How I Built This”
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