Angel Investors: Who They Are, Pros and Cons

One potential source of funds for new businesses is angel investors: private, wealthy investors who will finance your business in exchange for an ownership stake.

Here’s an overview of angel investors, some pros and cons of this kind of small-business financing, how to determine whether it’s right for your startup and how to bring potential angel investors on board.

Angel investors are typically high net worth people who fund startups or early-stage businesses. Many are accredited investors with a minimum net worth of $1 million or at least $200,000 in annual income. Angel investments can be thousands to millions of dollars, depending on business size and ownership sold.

Angel investors are often accredited investors, which is a designation that requires a minimum net worth of $1 million, at least $200,000 in annual individual income or at least $300,000 in annual joint income (see the Securities and Exchange Commission website for details). People who hold a Series 7 license (a broker license), a Series 65 license (an investment advisor license) or a Series 82 license (a private securities offerings license) may also qualify.

Angel investors can be friends, family, members of your professional or social networks, individual angel investors or a team of investors. Angel investors often form “angel groups,” in which they evaluate businesses and invest together, pooling resources to make larger investments.

Angel investors typically want ownership in the company they invest in. An angel investor usually provides capital in exchange for equity (stock in the company) or convertible debt, which is a loan that can be converted to equity at a later date.

For example, a company that's valued at $1 million might sell 20% of its equity, worth $200,000, to an angel investor or an angel group.

Generally, angel investors are interested in high-growth, high-potential startups that can earn them several times their original investment. In other words, the potential rewards need to be substantial enough to outweigh the numerous risks of investing in a startup.

Advantages of angel investors

• Expertise. Angel investors often have industry expertise. They may be entrepreneurs who started a business in your field and can provide advice and coaching to help you succeed.

• Connections. Angel investors may have a lot of industry connections. They may be able to introduce you to new customers, financing sources, business partners and other relevant contacts.

• Support. Because they’re owners, angel investors typically make money only if the business is successful. This position should motivate them to help add as much value as possible.

• Deep pockets. If your small business needs financing later, angel investors might make follow-up investments.

• Alternatives. Angel investors might invest even if a business can’t get financing from a bank or a financial institution.

Disadvantages of angel investors

• Potential rejection. Even if you think your company offers outstanding growth potential or a game-changing product, angel investors still might reject your pitch. After all, investing in a startup is risky.

• Shared control. Some angel investors might demand a large ownership position, and you may end up selling more of the company than you had planned.

• Possibly unhelpful. Do due diligence on an angel investor to ensure their interests are aligned with yours. Ask for references and, if possible, talk with other startups that raised money from this investor. You may prefer an angel investor who will be a business partner, help your company grow and contribute to its success, instead of one who's just looking for a return on their investment.

• Time and effort. You’ll likely need to prepare a lot of paperwork, such as income statements and projections, balance sheets, cash flow statements and bank statements, so be ready for a potentially lengthy, time-consuming process.

Startups and early-stage businesses that can be scaled for growth are generally the most attractive angel investments. This means your business should be able to increase its sales very quickly over the next few years without a huge increase in fixed costs and expenses.

If you’re willing to give up ownership and potentially control of your company — and think you’d benefit from bringing an experienced investor on board — then angel investors could be a smart move.

You can find potential angel investors in places like these:

• The Angel Capital Association, which is the official industry alliance of over 100 of the largest angel investor groups in the United States.

• AngelList, which helps match founders with investors.

• Gust, which evaluates various funding sources for startups.

• MicroVentures, an investment bank offering private market investments.

• The Angel Resource Institute, a nonprofit that provides education and information on the best practices in the field of angel investing.

• FundingPost brings entrepreneurs together with angel investors through its roundtable events.