My beginnings with angel investing all started after I founded my company, 97th Floor. You see, we worked with lots of different companies to help them with their marketing. Sometimes, they would suddenly come to us with a budget that was anywhere from three to five times what they had from the quarter before.
Obviously, this would surprise us, and we wanted to know what was going on. Why did they suddenly want to spend so much more money marketing their product? The answer, as it turned out, was that they had just raised a lot more money through venture capital or angel investors.
That got me thinking. I knew that these companies were pretty awesome at least six months or even a year before venture capitalists got involved. Why couldn’t I become an angel investor and jump on board a promising company early in the process? I started to dip my toe into those uncertain waters, and before long, I had fully embraced angel investing.
Entrepreneurs have the opportunity to become angel investors if they want to. This allows you to support a small business when they need it most, help transform the world and make it a better place, and, yes, even earn some extra money through smart investments.
That doesn’t mean becoming a successful angel investor is easy, though. It can all go wrong in a hurry if you make bad decisions. Far too often, this happens when people fail to follow their true north and go against their principles, aiming for the easy buck instead of what they know to be right. You don’t have to fall into this trap. I’ll show you how to stay true to your values while still being a successful investor in up-and-coming businesses.
In this article, you’ll learn:
- What angel investing is
- How it works
- The pros and cons of angel investing
- How you can succeed as an angel investor
What Is Angel Investing?
Angel investing involves those individuals of a high net worth who invest their money into new businesses. This type of private equity investing relates to angel investors who take on a higher portion of risk in order to receive a higher return on their investment. This is usually considered a riskier investment when compared to public market investing. Most angel investors will invest their money at an early stage of a company’s growth.
How Does Angel Investing Work?
So, what is an angel investor, and how does it all work? As noted above, the first step in how to become an angel investor starts with how much money you have. The net worth of an angel investor should be at least one million dollars, and their annual income should reach at least 200,000 dollars, or they may have a joint income with their spouse of 300,000 dollars. Angel investors also need to become officially accredited investors as determined by the guidelines of the SEC.
After reaching those qualifications, the process is fairly straightforward. An angel investor will give a company a certain amount of money in exchange for a specified amount of equity in that company. The investment will be filed with the SEC as part of the record-keeping requirements. Many angel investors are part of what are called angel groups, where multiple investors band together to invest in a company. This allows them to make much larger angel investments than they would on their own. According to a report from the Angel Capital Association, angels can invest as much as 90 percent of the money companies raise. It can be a risky move, but it can also pay off significantly should the company take off.
The Pros and Cons of Angel Investing
- Possible gains: The returns an angel investor could gain from their investments are tantalizing. While there are other relatively safer investments out there, if angels hit on the right company for the right amount, they could see a huge return on investment.
- Relaxing on the side: Angel investors don’t need to run the companies they invest in. Instead, they sit in the stands and watch it all play out in front of them, like a fan that paid to attend the game. Of course, you can get more involved as a way to help companies, but that’s optional. Once you’ve given your money, your obligation is over.
- Support your causes: Becoming an angel investor means you get to put your money where your mouth is, so to speak. You can actually financially support businesses that you believe in, ones that can improve the world around us. You get to direct that money instead of letting someone else handle it.
- Diverse portfolio: You’ve likely heard the advice from financial experts that you should diversify your portfolio. Angel investing is one effective way to do that. By investing in startups, you can ensure your portfolio doesn’t go stale.
- Encourage innovation: When you invest in a new company, you’re also helping to drive innovation. Most of these businesses will utilize new technologies, and since you’re helping fund them, you’ll stand at the forefront of technological leaps.
- Higher risks: Think of how often new businesses don’t work out. The Bureau of Labor Statistics says that 45 percent of new companies close their doors in the first five years, while 65 percent do so in their first decade of existence. You certainly run a high risk of the company you support not making it, and if they’re not successful, you lose everything you invested in it.
- Tax considerations: It shouldn’t come as a surprise that when you make significant investments like this, you have to take the IRS into account. The rules involving angel investments can be complex, so you’ll likely need extra help to navigate them.
- Uncertainty over funding: The business you invest in might be one you find very intriguing, but that doesn’t mean other angel investors will feel the same. There’s always a chance the company never gets the amount of money they need to succeed.
- The waiting game: With angel investing, you might have to wait awhile before seeing any returns. The goal for many is to see the company go public, and that can take anywhere from five to ten years, if not longer. Be prepared for a wait if you want to invest.
How to Succeed as an Angel Investor
1. Find Your True North
Peace of mind comes when your life is in harmony with true principles and values and in no other way.Stephen R. Covey
I mentioned this earlier, so allow me to expand on it a bit. Your success as an angel investor will partly depend on you knowing what your true north is and following it. When I say true north, I mean knowing what it is you stand for. Just as a compass can guide you to where you need to go, having a true north means living by a set of principles and values that provide you with direction. This is true with a lot of endeavors in life, not the least of which is what you invest in.
There are a lot of opportunities to make some big money in the world. Many people get into angel investing with that goal in mind. However, if that’s all you want to do, you’ll likely end up losing money in the process. When you have a true north, you’ll know what companies you want to back and, more importantly, why you want to back them.
For example, I’m really into healthy food. If I want to invest in a company that offers a new healthy snack, I’m not going to look at the financials first thing. Instead, I’ll look at the ingredient list. If the snack contains an ingredient that I’m against, I won’t back the company. In that instance, my true north is that I don’t want to invest in products that aren’t good for people’s health.
How to find your true north:
- Identify the core values you want to live by
- Find a problem in the world that you want to solve
- List the values, characteristics, and traits of the type of people you want to work with
- Think of a cause you want to fight for
- Note the principles that you would never sacrifice no matter the reason
2. Set Monetary Parameters
Just because you can afford it doesn’t mean you should buy it.Suze Orman
There’s a great deal of excitement when it comes to angel investing. New companies come along with grand ideas, and the temptation is to jump at the first opportunity no matter the cost. But just as it’s important to set a budget for yourself in your personal life, you need to set financial parameters with your investments. You can’t go diving into every cool-looking company you come across.
Setting financial parameters serves as a way to protect yourself. Think of it sort of like going to buy a new car. If you set a limit for how much you want to pay for a car and stick to it, you won’t come to regret the purchase. Sure, the salesperson might show you some fancy cars with the latest accessories that sound amazing to have, but if you stick to your limits, you won’t get yourself into a financial mess by buying something you can’t afford.
The main thing to know is that a lot of these opportunities are going to look incredible. Some may even seem like “can’t miss” investments. Stick to your parameters no matter what. Otherwise, you may end up hurting yourself.
How to maintain your financial parameters:
- Determine how much you want to allocate per year
- Work backward from there to figure out how much you can spend quarterly and monthly
- Never deviate from your budget no matter what opportunity arises
- Do your due diligence on each company
- Roll any money you don’t spend into the next quarter
3. Establish Deal Flow
Supporting another person’s success won’t ever dampen yours.Anonymous
You always need to keep an eye out for potential investments. Doing this will help you establish deal flow. As you continue to search, you’ll have more opportunities to make deals. Pursuing this strategy provides some definite advantages. One of the most significant is that you can compare deals against each other, leading to better choices all around.
If you keep to only one deal at a time, all you end up doing is weighing the one deal versus the money that’s just sitting there in your account. Keeping an eye out for multiple deals means making sure you’re putting your money in the right place.
How to get extra deal flow:
- Update your LinkedIn profile to indicate you’re an angel investor
- Mention you’re an angel investor when you talk to people
- Indicate you are specifically looking for investment opportunities
- When you invest in a company, talk about it on your social media platforms
- Continue to share more about the company you invested in to show that you back companies in their early stages
4. Do Your Research
Without data, you’re just another person with an opinion.W. Edwards Deming
As I mentioned above, doing your own due diligence is a crucial part of becoming an angel investor. When you do your research, you closely examine these investment opportunities to see what is substance and what is just hype. Is that company the diamond in the rough you’re looking for, or is it all a show?
Recognizing when an opportunity is empty is key to making smart investments. You don’t want to waste your money on something that won’t get a return. With this in mind, do things like look at the financials and interview the founding team. This is your chance to really get to know them and their company. You’ll never regret going the extra mile in researching potential investments.
How to conduct thorough research:
- Test out the product to see if it does what the company says
- Check out their social media accounts and communities that they’re part of
- Study their marketing analytics
- Get experts in other fields involved in the research (you don’t have to know it all yourself)
5. Reduce Your Risk by Getting Involved
People who get involved with the success of something have to be given at least some share of that success.Michael Ironside
The risks associated with angel investing may turn some people away, but there are ways you can reduce those risks. For most people, they simply invest their money and stop right there. Their work is done, and now it’s up to the company to produce a return. If you go that route, however, then you’re at the mercy of the company. You’re crossing your fingers, hoping that they get it right. Instead, you should get involved in any way you can.
For me, I get involved from a marketing standpoint. That’s my area of expertise, and since I want to see the company succeed, I help them by connecting them with the right people. This is kind of like sweat equity, and you’ll be doing a little more work than what you might think at first, but it’s an important part of reducing risk. As I become more involved, I increase the chances of the company doing well.
This happened with one company I invested in called Magic Spoon cereal. I saw the potential there and put the founders in touch with Space Station Integrations, which is an influencer marketing agency. That agency put Magic Spoon in the hands of influencers, and the brand took off. My help reduced the risk of failure and increased the chances of getting a great return on my investment.
Have an Infinite Mindset When It Comes to Investing
Another key to becoming a successful angel investor is to always keep the big picture in mind. You’re not going to make an instant return on your investment. It takes time—sometimes a long time. I’m talking about five, seven, or even ten years. Have the patience to see things through.
As you do so, try to keep an infinite game mindset. This allows you to focus on transforming the world instead of just playing to win or lose. Having a winning or losing mentality like that fails to set you up for the long journey you need to take with your angel investments.
To learn more about having an infinite mindset, check out this article on The Infinite Game. And if you’re running a business, learn how to find investors.