What is Angel Investing?
and how it works as a founder and angel
TL;DR
Angel investing describes individuals who invest in private companies, often at their inception. Ideally, angel investors provide not just capital but also experience to help young companies thrive.
In practice, angel investors are often family, friends, and colleagues (current and former) who know and trust the founder. This dynamic affects who gets funding.
Early-stage companies fail. A lot. Federal and state law only allows people with certain levels of income to invest in private companies (called “accredited investors”).
Angel investing has become more professionalized, while venture capital funds are investing earlier and earlier.
What is Angel Investing:
Angel investors are individuals who invest in private companies. To qualify, angel investors must be “accredited.” Accredited investors (and qualified institutions) are allowed to invest in private companies, while the general public cannot.
Why, you ask? Private companies are high-risk investments with limited disclosure requirements. In contrast, public companies are open to all investors because the SEC mandates regular disclosures, ensuring transparency so the public can make informed investment decisions.
Private companies are not subject to these same requirements, so the SEC requires accredited investors to have a net worth of over $1M (excluding their primary home) or annual incomes of $200K (individual) or $300K (couple) for at least two years. Alternatively, you must be a professional investor to invest in private companies.
It’s somewhat arbitrary that income levels define aptitude for private company investments. There is ongoing effort to update this, but for now, the SEC is still operating under regulations originating as a response to the Great Depression. (For policy buffs, the Investment Company Act & Investment Advisors Act of 1940 are key foundational texts. OpenAI also provides a good primer of securities legislation!)
How Does Angel Investing Work:
As an Angel Investor…
Angel investors buy stock in private companies, hoping the value of their stock rises and eventually sells for more than they invested (ideally, a lot more!).
Angel investors contribute capital to startups with the hopes of earning a significant return. This “high-risk, high-reward” model means that the few successful investments ideally offset the many that may fail.
Angel investors often invest between $5K and $100K in one company, although this varies based on the investor’s and founder’s preferences.
Typically, angel investors aim to back 20-30 companies in the hopes that 2-3 will succeed phenomenally and make up for the companies that didn’t. For instance, out of ten companies, only one or two might yield returns.
Angel investors often focus on founders they know and sectors they understand. This approach can aid in making informed decisions, though it’s not a strict rule.
Example: I focus on consumer, SaaS, and fintech companies because I understand those sectors and know founders working in those areas. In my last investment, I contributed $5K to a fintech company valued at $5M, meaning I own 0.1% of the company. Over the next 5-10 years, I expect this value to grow as the company expands its revenue, customer base, and profitability. Ideally, the company will either go public or be acquired. So, how do I make money? Let’s say the company is acquired for $500M in ten years. My $5K investment could become around $500K (pre-tax!). But keep in mind, I’ve made ten other $5K investments. In angel investing, it’s often one success that makes up for all the others.
As a Founder…
Look for angel investors who bring both capital and valuable expertise or connections. It’s also helpful if they have experience with angel investing and understand the long-term, high-risk nature of these investments—and know they’ll need to sign documents in a timely manner!
Over time, angel investors can become great partners, especially since their financial incentives will likely align with yours as a founder. This alignment may become even clearer if you raise funds from venture capital or private equity firms later on.
Some angels may request that you establish a board of directors. If you do, a three-person board (two founders, one independent) can be effective. Brad Feld has excellent insights on this topic. Remember, a board’s main power lies in its ability to hire or fire the CEO.
To protect your company, investors self-certify as accredited, meaning that they, not you, bear the liability if they misrepresent their qualifications.
Why Does Angel Investing Matter:
Small businesses are central to the U.S. economy, creating jobs and fostering economic growth. After personal savings and credit cards, angel investors are often the next funding option for many startup founders.
Personally, I find angel investors invaluable. They often take a broader, longer-term view of investing compared to professional investors. While many angels want to make money, they also want to make a positive impact. This mission-driven approach isn’t limited to tech startups—it extends to all types of businesses. That said, be discerning about whom you allow to invest in your company. Some investors may consume your time and patience as a founder. Use your judgment, trust your instincts, and always do thorough reference checks with other founders and mutual connections!
Naturally, many angel investors prefer to invest in founders they know and trust, which often means founders may look like their investors. Unfortunately, this dynamic has historically left out women and people of color, though this is (slowly) changing.
It’s also unusual that U.S. law uses wealth as a criterion for private investment eligibility. I’m in favor of a qualification test for accreditation, similar to a CFA or Series 7. That said, successful angel investing typically requires enough capital to invest across multiple companies to spread risk and increase the chance of returns. In that respect, the income threshold is a practical, if imperfect, benchmark.
Curious how to evaluate startups as an angel investor? We’ll walk through that in more detail in the next post.
Additional Reading:
Speeches:
Don Valentine at Stanford GSB View from the Top (if you listen to one thing, listen to this!)
Blogs:
AVC, Fred Wilson (a consistently wise blog from a VC veteran)
Gotham Gal, Joanne Wilson (a consistently wise blog from an veteran Angel)
Angel Investing Archives, Brad Feld (great for the 101’s and logistics of angel investing)
Books:
Venture Deals, Brad Feld (how a deal gets done)
Thinking Fast and Slow, Daniel Kahneman (how to make wise decisions, including in venture)
Shoe Dog, Phil Knight. (my favorite book on entrepreneurship)
Podcasts:
Acquired (deep dives and analysis into your favorite businesses…its like getting an MBA)
20VC (concise interviews from some of the best professional investors in the business)