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Merging Traffic Staff

February 28, 2017

What is an Angel Investor and How to Become One

If you are interested in making a long-term profit, you may want to consider investing in start-up companies as an Angel Investor. Start-ups are brand-new companies that are still growing and establishing themselves in their particular market sector or industry. Many of today’s largest companies began as a traditional start-up and have evolved thanks to angel investors and other investors.

What are angel investors? How are they different from other types of investors?

Below, we will take a look at what angel investors are, what they do, and how to become an angel investor. You will find out everything you need to know about how you can benefit from an angel-investor relationship with a start-up, and how your investment will benefit the company as well.

What are Angel Investors?

Angel investors tend to be wealthy individuals interested in investing in a company, usually a start-up. They range in professions, from business owners to doctors, lawyers, and fellow entrepreneurs. Angel investors are looking to invest in a start-up company in exchange for a share of the profits or stocks. They tend to invest in high-risk start-ups BEFORE the start-ups show any serious profit or revenue.

There are many of different types of investors that may appeal to start-ups. In fact, the heads of most start-ups spend time evaluating each type of investor to determine which is the best fit for their company.

  • Angel investors – As mentioned above, an angel investor tends to be a high net worth individual interested in investing in a start-up in exchange for a percentage or portion of the company’s profits or revenues, or for a share of the company itself.
  • Venture capital investors – Venture capital is usually offered by a firm, company, or hedge fund that manages other people’s money. Venture capital investors do not risk their own money, but instead help their investors profit through diversified investments into the success of high-growth start-ups.
  • Private equity investor – A private equity investor is usually a firm or an individual seeking to take control of a business. They invest large stakes in established companies or start-ups to acquire a controlling or substantial share of a company and then take over operations in efforts to maximize the value of their investment.

Friends and Family Investment Method

When entrepreneurs are seeking money to fund their start-up venture, they usually approach friends and family first. While the start-up venture may have great potential for success, friends and family rarely have the business background or expertise to truly evaluate the start-up’s potential. Instead, they invest from emotion or out of obligation with the belief and expectation that their investment will help the success of the company and that they will receive a share of the profits or revenues in return. Almost inevitably, the start-up will need further financial support not available from friends or family. This is when entrepreneurs turn to an angel investor.

Analyzing the Prospectus: Worth the Risk?

When a start-up is looking to raise capital, a prospectus is usually created. A prospectus is a legal document issued by the company offering securities for sale with details on the funding strategies the start-up is willing to consider, including the fund fee structure, the manager’s background, and the financial statements. The prospectus is circulated among potential investors to review.

Because it covers everything from the state of the company financials to the incentive for the investors, the prospectus is a complete document that should give angel investors a clear idea of what to expect and help them determine whether the reward is worth the financial risk.

Angel investors can negotiate for a higher stake or a lower investment. A start-up desperate for funding gives angel investors great leverage. Investors can ask more than a share of the company. They can also demand active management roles or even board seats.

Many entrepreneurs will avoid offering management or board seats as part of their pitch to angel investors. However, if an angel investor has solid business experience, he or she may actually benefit the company in the long run. If you feel your experience or expertise can add value to the start-up, it is worth holding out for a board seat or management role as well as a share of the company in exchange for your investment.

The truth is that angel investors play a very large role in the success of start-ups. It is estimated that each angel investment creates 3.6 jobs, with more than 12% of equity received in 2014 coming from angel investors. Over $24 billion dollars of investment in 2015 came from angel investors.

Who Should Become an Angel Investor and Why?

The U.S. Securities and Exchange Commission has a set of rules for becoming an investor. Rule 501 of Regulation D of the Securities Act of 1933 defines what is required to become an investor.

Angel investors are required to have a net worth of no less than $1 million. The annual salary per year is $200,000, or $300,000 together with a spouse. If you meet those financial requirements, you are legally able to become an angel investor.

In reality, you will probably need more funds than this minimum requirement. Start-ups regularly fail, meaning you are at risk of losing your investment. There is no way to predict with 100% accuracy the success or failure of a product or service. All you can do is thoroughly research the start-up, be smart with your decision making, and hope the start-up succeeds. If it fails, your investment is lost.

This risk is why angel investors tend to invest in multiple companies at once, often up to 10 or 20 start-ups and the like. The typical investment ranges from $25,000 to $50,000, but the minimum is $25,000. The more companies you invest in, the higher your chance of success—but also the higher the chance of failure.

Below is a list of a few of the risks and benefits of becoming an angel investor:

Risks:

  • Emotionally demanding – You are investing more than just your cash into the company; you may also be emotionally invested, in hopes it will succeed. It can be nerve-wracking to be a part of the highs and lows that come with being involved in a start-up company.
  • Investment of time and money – Not only is your hard-earned capital being invested in the company, but you will also want to invest sufficient time to see it succeed. That may mean being a part of the decision-making process or even taking a direct hand in the day-to-day operation of the company.
  • High chance of failure – Start-ups are a gamble that can either pay off big or not at all. It is not a “safe” investment, so it is one you should consider carefully.

Benefits:

  • Helping others – You have a chance to make others’ dreams come true and help them succeed. There is deep fulfillment in playing a role in the success of others. Being a mentor, “angel,” or solution that propels the company and its stakeholders to realize their vision can be equally, if not more rewarding than the financial pay off.
  • Potentially making profit – If the start-up succeeds, you have a chance of earning a huge profit. Facebook bought Whatsapp for $22 billion, while Google bought YouTube for $1.65 billion. Imagine the profits made by those who invested in those companies!
  • Mastering New Skills – Not only will you learn about the new company and its employees, but you will probably be entering a new sector or market niche. You may be called on to fill positions or carry out duties that are new to you. It is a learning process, but one that will improve you as a professional.

The truth is that being an angel investor does carry risk—the same amount of risk involved in starting a new company or launching a new brand. But if the gamble succeeds, it can be highly worth it in more ways than just monetary.

Steps to Becoming an Angel Investor

As you can see, becoming an angel investor has plenty of benefits along with its risks. There are myriad reasons to consider becoming an angel investor—beyond financial gain, there are personal and professional rewards.

Once you have decided that being an angel investor suits you, there are steps to take before your can invest in any start-up in this role. Here is what you need to know:

Step 1: Meet the standards – As mentioned above, you must have a net worth of over $1 million and an annual salary of $200,000 in order to become an accredited investor. Obtaining accreditation from the SEC is the best way to ensure your investment is considered. Many start-ups won’t consider non-accredited investors, as accreditation exempts those investments from securities filings.

Step 2: Know the risks – Do not jump blindly into the first investment opportunity that lands in your lap. Make sure you understand what you are getting into with these start-ups. You could end up losing your investment and have nothing to show for it if the business goes belly-up. Understand the risks before you consider the rewards.

Step 3: Talk with other angels – The more you learn about being an angel investor, the easier it will be to take that leap when the time comes. Find out investment strategies, start-up red flags to consider, and anything else you can. Spend time talking with other angel investors and learn how they operate and what has contributed to their successes and failures.

Step 4: Learn the ins and outs – Take time to educate yourself on angel investing, what you can and can’t expect from your investment, and how the process works. Use the resources provided by the Angel Capital Association to learn as much as possible. When an opportunity presents itself, educate yourself on that industry or market sector. The more educated you are, the better your chance of making the right decision.

Step 5: Be prepared for the long term – Angel investments are “illiquid,” meaning they are a long-term investment that will not yield a lot of cash flow initially. It may take many, many years for you to see a serious return on your investment. When considering angel investments, be prepared for the long wait.

Step 6: Consider industry-specific start-ups – If you have experience in a certain industry or market sector, look for opportunities in that sector or niche. That way, you can use your experience, network, and company to increase the start-up’s chances of success.

Step 7: Join angel groups/communities – Become a member of groups like the Angel Capital Association, Sierra Angels, and other communities and groups for angel investors. Not only will these groups provide you with more potential investment opportunities, but they will also connect you with groups of people willing to help you learn the ropes of the angel investing process.

Step 8: Be ready to take that risk – When the time comes, be ready to take the risk. Once you’ve done all the work of preparing to be an angel investor, it is time to act with conviction. That first investment is always a huge step, so you have to be in the right frame of mind to take the chance.

Being an angel investor has a lot of benefits, including high potential earnings, professional gains, personal fulfillment and so much more. The risks do exist, but when there is a great chance for success, angel investing is well worth considering.

If you want to learn more about the angel investing process or find smart investments, let Merging Traffic help. We are a web-based, crowdsourcing portal for capital formation and an investment pool targeting earlier stage companies. We offer a unique combination of targeted fundraising and diversified fund investments. With our help, you can find the investment opportunities you seek.

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