I seem to be having more and more conversations about angel investing. Austin, with our surplus of startups, has had a growing angel community for years. With new solicitation rule that make it easier to learn about opportunities, early-stage investing is growing in popularity and gaining more attention. Last week The Wall Street Journal ran this article which I think does a great job of summing up the most basic and important points for someone who wants to know what angel investing is about. So what is an angel investor?
Angel investor – an affluent individual (you need to be an “accredited investor”) who provides capital for a business startup.
According to the WSJ, total angel investments in 2012 was $22.9 billion, with an average deal size of $341,800. The number of investors and dollars are growing at digit rates each year. Some angels invest alone, but there are an increasing number of groups and networks where research is shared and/or capital is pooled.
What do you need to know about angel investing? It is NOT like the stock market.
- It takes more hands-on work. The initial assessment of an investment is much more difficult when the company has little or no real track record. You have very little public record to research, which means you have to roll up your sleeves and do some digging. Visit the company, talk to the founders, check out the competition, go see customers, etc. You are investing in an idea.
- Once you have invested, you are expected to get involved with the startup. The founders will want and need your help with the business, and it will be in your best interests to provide it. The level of time commitment varies depending on the company and your area of expertise.
- It is illiquid, for years. You don’t get to choose when you cash out. Generally the only way you get your money back and potentially make a profit is an IPO or acquisition.
- It is risky. WSJ quotes that roughly three-quarters of venture backed firms in the US do not return investors’ capital. (Translated: total loss.)
- You can’t really diversify. Sure, do more than one deal. However, due to the amount of time required to select a company and then be a committed investor, the shotgun approach doesn’t work here.
- Have someone look over the legal documents. Unlike publicly traded stock, the terms and conditions DO vary. So have a legal advisor who knows what to look for review the documents.
- Don’t fall in love. If a company is struggling and has come back to you for more funding, you have to know when to walk away.
Angel investing, the opportunity to be in on the ground floor of the next big thing, can be exciting. We hear the success stories of those few winners who strike it rich. But it is important to know the risks and commitments before you jump in.