Angel investing: Getting started, the risks and why it’s more accessible than you may think
Over the past two decades, angel investing has become a serious form of money making. But today, it’s not reserved only for the rich. You too can do your own angel investing on various platforms to help budding businesses get off the ground and share a piece of the profit.
If you have an appetite for risk, then pull up a chair to discover the benefits, risks and the ways you can begin to angel invest.
Remember: All investing involves risk. The content of the podcast is for informational purposes only and is not investment advice. Please always use caution and diversify.
Hello and welcome to the 18th episode of Alternative Investing. I’m your host, Trevor Kraus, Communications Manager at MyConstant.
Going into today’s podcast I realized that the last three podcasts I recorded all involved cryptocurrency. And for listeners who are not crypto investors, I don’t want you to think that the only thing I’m discussing here is crypto.
So today, I’m going to step away from crypto and discuss something that happened in my life recently and that is: angel investing.
If you’re not familiar with angel investing, it’s basically investing your money in small start ups or entrepreneurs typically in exchange for ownership equity in the company.
Often, angel investors are found among an entrepreneur’s family and friends. The funds that angel investors provide may be a one-time investment to help the business get off the ground or an ongoing injection to support and carry the company through its difficult early stages.
So how does angel investing work exactly? What are the risks? And if you don’t personally know someone who needs funding for a project, what are the platforms that you can check out to get involved?
For me, the first time I ever heard of angel investing was around 12 or 13 years ago. I was working at a restaurant outside Philadelphia and there was an older woman in her 70’s who always came to our bar and ordered a Coors light in a tall glass with ice. And this, my friends, is why you shouldn’t judge people by what they order at a bar, because she drove a big black Mercedes coupe and she was quiet, kept to herself.
One day I asked her what she did for a living and she told me she was a “full time” angel investor. She inherited a lot of money from her family and would invest in local tech companies. That was basically her income. I got to know her a little bit more and she’s actually a very cool lady, very candid and unpretentious about her work.
When most people think of the tech industry, Northern California — silicon valley specifically is the first place that comes to mind. But the suburbs west of Philadelphia pride themselves on being a mini silicon valley. The region is brimming with all the major pharmaceutical companies, tech start-ups.
You have Lockheed Martin, Siemens, Vanguard. And on top of that, you have the state of Delaware which is close by and is practically a tax haven for countless companies. It’s a small area concentrated with really bright people.
I’m telling you this because if you’re not from Philadelphia you might be wondering why someone would be investing in tech startups outside of California. But anyway, that was my first introduction into angel investing.
Around this time the show, SharkTank was growing in popularity and that entire program is focused on a sort of angel investing. I’m hesitant to say angel investor because if you’ve watched Shark Tank, the panel can be sharp tongued and more wheeling and dealing when it comes to their stake in the company. I know Mark Cuban has famously stated that he’s not an angel investor and not a venture capitalist—he’s just an investor.
So after meeting this woman, my primary notion about angel investors was that they were generally wealthy people who could afford to take a risk in supporting a company that hasn’t gotten off the ground yet—still in the beginning stages.
In the world of angel investing, these early stages are called the “seed” or “angel” funding phase. This could mean that an investor is giving money when the company doesn’t even exist or is just an idea.
In some cases, there are multiple rounds of funding. And the earlier you get in, the more equity you’ll hold in the company (if it takes off). Sometimes angel investors arrive on the scene after the initial round of funding. This initial round of funding will often come from family and friends.
Typically, initial business funding from family and friends isn’t substantial—it’s common for founders to roll out their product or service with $10 or 15,000 of initial funding.
Another time that angel investors will swoop in is at a critical inbetween stage of a business. Think of it like, if you’re a start up and you get all this money from your family & friends and you’ve gotten the basics of your company, but you’re not at the stage where a venture capitalist company hasn’t noticed you yet, but maybe will. This is when you need an angel investor to come in and hold the ropes for a couple months right before you shoot up and grow.
Think of it as a growth spurt period when you’re 12 or 13 years old.
Anyway, speaking of venture capitalists, oftentimes people confuse or conflate the two.
While angel investors and venture capitalists both fund companies in exchange for a piece of the action, there are significant differences between the two.
Even though both angel investors and venture capitalists invest in startups, they typically put in money at different stages in the process. Which is what I touched upon before.
An angel investor is more likely to provide capital for an idea whereas most venture capitalists would like a proof of concept in hand.
Another difference is the source of funds: Angel investors are private investors that invest their own money. Venture capitalists are professional investors who generally invest other people’s money, rather than their own money—although that’s not to say they never put in their own dollars.
The final major difference between the two is that angel investors take a “hands off” approach to the startup they invest in. They have faith that their money is being used correctly and whoever is running the company is making the right choices.
On the other hand, venture capitalists might take a more involved approach and voice their opinions about what’s going on in the company.
As I mentioned before, my initial ideas about angel investing was that it was primarily for the very wealthy, like the woman I mentioned who drank Coors light with ice, who could easily afford to throw money at projects. And if some failed, maybe it wasn’t a big deal for her.
So last week, I was personally approached, out of the blue, to do some angel investing. Before I tell you what I invested in, I just want to give a disclaimer that I’m not promoting any company, I’m just relaying my experience.
Basically, I have a good friend, Pepijn, who is a serial entrepreneur, smart guy, worked for a long time at one of the major consulting firms in New York. And is now starting ecommerce company called Zelf which basically connects consumers with live stylists. It also centralizes the checkout process.
So if you see an outfit you like online and it’s made up of different designers, you can purchase the entire look with one click or pick what you want without having to go to each store’s website.
When my friend, who’s the CEO, asked if I wanted to invest for a percentage of equity in the company. I at first thought he was barking up the wrong tree. I reminded him that I’m not rolling in cash so he wouldn’t be getting 40 or 50 grand from me. But he reminded me that at this stage there was no minimum that I could invest.
So I went ahead and invested some money, I won’t give the exact number but it was enough that I felt okay parting with. It’s important to remember that no matter how confident you are in the company or person you are investing in — angel investing is very risky. It’s a classic high risk, high reward scenario.
Pepijn was actually telling me that when he approached some family members about investing, they expected to get the money back if things didn’t work out. And he had to tell them, no — it doesn’t work that way.
When this opportunity came to me, the first thing I thought was yes! People invest their money all the time, but it’s quite exciting and different when you have a friend with a good idea and smart people behind the p[roject. It makes you feel personally involved. And that’s something that’s often absent in investments—especially in the stock market. Things can seem abstract and you have no real idea where your money is going.
But what I did was instead of impulsively signing the SAFE document (SAFE stands for simple agreement in future equity) and sending my money, I took a step back and I sent Pepijns deck and info on his company to two friends who don’t know him. Because I wanted to get an objective opinion on this potential investment.
Obviously, opinions are a dime a dozen, but I think it’s good practice to see what other people—particularly ones who might use the service or platform—have to say.
I also give myself two or three days to think about it. Anytime money is leaving your wallet it’s good to mull it over.
So once I decided I wanted to invest, I carefully read the SAFE agreement, I had a friend who practices law read it over and once I signed, I wired the funds.
Now, it might be a few years, (or never if the project tanks), that I get my money back or earn equity in the company.
But I tell this story because it proves that angel investing is possible. I think if you have faith in the person or people who are running the company or if the idea is so enticing to you it’s an alternative investment that you should consider.
Now, I’ve talked about my small experience with angel investing, there are things you should consider and there are certainly risks. So let’s get into them.
It needs to be said that angel investing is risky. When Pepijn first contacted me he was extremely candid and told me I should consider the money that I invest as being potentially flushed down the toilet. And he said this not because he didn’t want my investment, but because it is so high risk. It’s almost like taking your cash and playing the slots in Las Vegas. But in a way, him verbalizing that to me made me more comfortable because I didn’t feel like he was trying to sell me snake oil.
Beyond losing your money if the company goes bust, you also need to consider valuation and reduced promoter stake.
In order to sustain growth and to scale up, startups are in constant need to raise funds periodically. However, this also means that the earlier you invest in startups; the more your investment will be diluted in the subsequent investment rounds.
This is why the eventual stake of an early angel investor at the time of exit may be significantly lesser than at the time of investing. This could not only decrease the overall voting rights but also lead to a loss in case the startup raises subsequent funds at a down round.
Another risk of multiple funding rounds is that eventually the promoter’s stake, which is the main driver of the venture, may also be reduced to a significant minority.
Valuation in startups is a grey area and though there are several mathematical methods to work out. That said, all of them are based on projections which have a risk of not being realistic.
Also, unlike publicly traded companies that are valued publicly through market-driven stock prices, the valuation of private companies, especially startups, is very difficult to assess.
A number of times, angel investments are made based on incorrect assumptions or without conducting adequate research and study of the market in which the startup being evaluated is operating.
This leads to errors in judgment while making an angel investment that therefore comes with an inherent risk to the investor. Sometimes, angel investments are made by tagging along with another investor in case he or she is an expert without actually assessing the potential of the idea.
This could lead to challenges in case the reference investor ignores some of the key business aspects while taking a lead in investing. This is why, it’s recommended to do a detailed analysis and due diligence of the startup opportunity before firming up a commitment to avoid any unfortunate shocks later.
Angel investors sometimes also have impractical return expectations within a timeline from their founders as a result, they end up over-pressurizing them to perform or compel them to change the business strategy frequently which can lead to instability and lack of focus.
Making an angel investment without a clear roadmap towards an exit is a major risk that angel investors can face.
I think the final two risks that you run into and should be considered are growth and competition risks.
It should be said that for a growth risk, A startup needs to have a scalable business model, in order to generate maximum value for its investors. However, as a startup grows it faces new challenges.
Expansion may place a great deal of strain on the company’s management, operational and financial resources. To manage growth, the company will be required to implement additional operational and financial systems, procedures and controls and this could slow growth.
From a coptetition standpoint, it doesn’t matter what sector you’re in, a startup will always have competitors and this is why it’s critical to creating entry barriers and compelling differentiators that safeguard its growth. Nevertheless, funding plays a key role in competition and well-funded players in the same space can prove to be a major risk for any startup due to their ability to tap opportunities, secure market space and scale up at a rapid pace.
As I mentioned earlier, most people get involved in angel investing if they either A) know the individual personally who is running the project. Or B) the project is of great interest to you and you feel passionately about the service.
If you want to try angel investing, but maybe you don’t have a friend, Wefunder is a terrific crowdfunding site that lets you invest in companies that you believe in.
If you go on their site you can invest in anything from food, to entertainment to technology. When you click on a particular industry, you’ll see different people’s projects come up.
They’re usually well explained, very detailed and you can invest in these companies for as little as $100.
Wefunder, and other crowdfunding platforms will give you different options in terms of how you make a return on your investment. Typically you get equity in the company so you really have a stake in how the company grows. Wefunder also offers you stock options with or without dividends as well as convertibles. Most early stage start-ups will use a convertible note or simple agreement for future equity — which is what I did.
But crowdfunding platforms might have other benefits. If you invest money, maybe you’re one of the first people who gets the product that you invested in.
From a start-ups standpoint, crowdfunding definitely gets the word out quickly and casts a large net. However, on crowdfunding sites, Wefunded included, there’s an investment cap and the platforms do take a percentage of earnings from the company (usually between 6 to 8%).
Crowdfunding is also less time consuming for the start ups. From the time that Pepijn asked if I wanted to get involved, we had zoom calls, emails back and forth, lots of explaining. And this was just for someone like me, who wasn’t even inventing a huge sum of money. So his independent footwork, in my view, is tenacious and extremely admirable.
In case you’re wondering, the most successful angel investor of 2021 so far is Marc Andressen. He’s a billionaire American software developer, entrepreneur and his main job now is funding all sorts of projects across the globe. His nose for successful companies is spot on.
Of the 37 companies he’s invested in, he’s had 27 exits. An exit in angel investing means that the start-up was sold to another entity. Basically, it got really big and the investors made a lot of money.
So I think wrapping this podcast up on angel investing, it’s good to remember some of these points.
If someone comes to you with an idea, take a step back and mull it over for a few days. Don’t be impulsive because for the most part when you give your money away. That’s it, it’s gone. So definitely do your due diligence.
I’d also say that the proposal you get from the founder or CEO should be thorough. And if you ask many questions they should have no issue answering them completely and in a detailed way. If the founder can’t express himself or herself to you succinctly, how on earth will they convey their product to others?
Have a realistic expectation on your investment. There’s a large possibility that you won’t get your money back — ever. Or you might start earning in the next year or two. In most cases, I wouldn’t expect to see an ROI for at least 3 or 5 years.
Keep in mind, Angel investors don’t usually acquire more than a 25% stake in a company. Veteran angel funders know that the company founders need to hold the highest stake in their own companies as they then also have the highest incentive to make their companies successful.
Risks in angel investing are abounding. Make sure that the founder or CEO has explained their view on risk, and research your own. One of the biggest problems with investments is that people don’t understand them. They hear a percentage return and get excited but forget to read the fine print. Holistic understanding is crucial.
So I want to say thank you for listening today, I personally found this to be an interesting topic. And if angel investing or crowdfunding is just too risky for your tastes, on MyConstant, you can invest your money in crypto-backed loans. When you do this, borrowers are getting the money that they want or need to fund their projects.
On MyConstant, you won’t know what the money is being spent on, but you’re still earning a safe and steady return (anywhere between 6 and 7%). We’re definitely a good option if you’re not into a high risk investment.
So if you have any topic ideas that you want discussed, do email me at [email protected]. Thanks again for listening. Goodbye.
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