Angel Investment - Explained
What is Angel Investment and How Does it Work?
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What is an Angel Investor?
Angel investors are high-net-worth individuals who seek to invest personal funds in early or startup-stage companies. Generally, these investments represent a given percentage of the angel investors overall personal wealth investment strategy. Startup companies provide a source of high-risk and high-potential-return investments within the Angels portfolio.
Angels look to invest in startups that provide a high degree of growth potential, proven management, and sufficient information about the company, its management team, and its market to be able to assess a company's value. Angel investment has never been more popular. Per a recent study, investors funded approximately 700,000 new businesses in 2012.
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What Value to Angel Investors Provide?
Early-stage startups generally need funds to grow operations and to created growth through marketing. The revenue produced by the company is not sufficient to cover the cost of achieving the growth targets.
As such, the startup that fails to seek outside funding is losing long-term value by failing to grow to the extent of its potential. As previously discussed, lenders are often not willing to lend money to fund marketing and similar growth-related expenses that do not have some form of collateral to secure the debt. Angel investors provide the much-needed, growth capital.
Angel investment deals are generally between $25,000 and $1 million. Higher levels of investment may require angels to group together to meet the funding requirements. Angel pools are discussed below. The angel understands that the invested funds are best used to grow the startups revenue. She does not want a routine return of capital from dividends or a profit-share; rather, she is looking to receive a lump-sum return on her investment at a future exit event.
Due to the high degree of risk associated with investing in startup ventures, the angel will seek returns of 10x, 20x, or 30x their money in a 3-7 year period. The exit event may be a new round of funding from angels, angel groups, or venture capitalist. In some cases the angel investor will stay invested in the company for many years in hopes of achieving a return from the sale of the startup to a large company, to an investment fund, or through a public offering.
How Involved are Angel Investors in the Startup Venture?
Angel investors often provide far more than capital to the business. Many angels are successful professionals or entrepreneurs. As such, they can provide valuable business experience for guidance in starting, managing, and growing the business. Angel investors vary in the degree to which they are willing or desire to take part in startup operations.
Most investors are silent owners who require specific levels of information disclosure by the company management. The investor will act as a director or advisor to the startup so as to take part in major startup decisions. The daily operations are left to the managers (entrepreneurs).
In some cases, angels will be highly involved in all decisions (even operational decisions). These are commonly referred to as guardian angels. They take an active role in business management as a manner of protecting their investment.
What are Angel Investor Pools?
While angel investors are high wealth-individuals who invest their own wealth, they often band together in groups to raise the investment capital needed or requested by a startup venture. In these situations, the angels act very similarly to a venture capital fund. The group will form a special purpose entity (generally an LLC) that will hold all of the Angels investment funds intended for the startup. This is important if the funding is called down by the startup as needed.
Further, the special purpose entity will hold the ownership interest (membership units or shares of stock) in the startup obtained in exchange for the investment. The individual angel investors then hold a percentage ownership interest in the special purpose entity. This arrangement aligns the interests of all investors and allows for coordination of investment efforts (e.g., single negotiation of terms, single set of investment documents, coordinated due diligence, etc.).
The angel pool will generally be manager-managed and one of the angel members will serve as manager of the special purpose entity. Similarly to a venture capital fund, this managing angel will often receive a management fee for their efforts.