An angel investor used to be defined as someone with a high net worth. They typically have more than $1 million and privately invest money in startup businesses that are seeking capital. The SEC restricts investing in private deals to mostly accredited investors. I say mostly because there are some opportunities for non-accredited investors to participate on a limited basis.
The definition of an accredited investor in the U.S. is a person who either has a net worth (excluding a primary residence) of $1 million, an income of $200,000 per year for the last two years, or $300,000 in household income per year for the last two years.
Angel investing has gained a lot of popularity despite anxieties over the bubble bursting. You need to understand what you are getting into before making that first investment. The general rule is that you shouldn’t invest more than 10% of your net worth, since startups can be risky. Investments typically range from $25K to $250K, but with startups needing less capital to launch these days, the amounts are shrinking.
Aside from the accredited investor rule, you don’t need to have any additional qualifications to become an angel, but you do need to make sure you understand the following concepts.
1. Be Ready to Write the Check
Make sure you have access to your capital so that when you find a great startup you have the money readily accessible to invest. You don’t want to have to wait to liquidate a CD or a stock, or try to get money out of your IRA and watch a great opportunity pass you by. Also, you don’t want to waste the startup’s time if you can’t get access to your funds. You can develop a bad reputation if you start committing and backing out of deals at the last minute. The startup community is a huge network, and word travels fast if you are unpleasant to deal with.
2. Understand the Risk
The majority of startups fail. As long as you understand the investment may be risky and you might not get your investment back, then you are at least being realistic when thinking about investing. If you stress too much while writing the check, it means it may not be the right time for you.
3. Investing In Multiple Deals
Given the high rate at which startups fail, it’s wise to spread your risk by investing in more than one. The goal is for a few successful startups to more than pay for the ones that fail. Ron Conway has made this “Spray and Pray” strategy successful. The thought is that you invest in a lot of deals early on and then narrow your focus in on those that are more successful and require additional funding.
4. Investing Takes Patience
You need to realize that even if your startup is successful, it could take five or more years to get your investment back. The most common way to get your money out of a private company is a liquidity event, such as a public offering or an acquisition by another company. Those events take time, sometimes even up to 10 years. Be patient.
In the past few years there have been additional opportunities for investors to sell off shares. For example, Groupon raised almost $1 billion, some of which was to allow shareholder liquidity. Also, new platforms like SecondMarket and Sharespost help with liquidity by linking your company shares with an interested buyer.
5. Understand the Exit Strategy
Every startup should have a clear exit strategy that they can share with investors. They should have a list of competitors who might be interested in an acquisition or the plan could be to go public like LinkedIn or Facebook. If you’re not clear on how the startup is going to exit, or they can’t give you a list of potential competitors, you should think twice about investing.
6. Mentoring and Connections
While you’re assessing a startup for investment, the startup is probably looking at what you can bring to the table besides a check. A big part of angel investing is helping out the companies you invest in by either mentoring them or connecting them to additional people who can help them succeed. In the end, investing isn’t just about the money.
Helping an entrepreneur who is trying to build a great company can be extremely rewarding. You are also surrounded by smart, creative people who come up with really interesting ideas. The downside is that it never gets any easier saying no to someone who is passionate about a project.
by Bill Clark, the CEO of MicroAngel Capital Partners, a venture firm that gives more investors access to alternative investments. He also gives investors the ability to invest in startups online through crowdfunding.