There are several things to consider when thinking about angel investing. The first, and arguably most important, is that angel investing is not for the faint of heart. Angel investing is risky. Often it is extremely illiquid, even less liquid than real estate. You are placing your money in the hands of a very early and unproven venture. If you think that any of these things would keep you up at night, angel investing is not for you.
Another thing to consider is how much of your portfolio you’d want invested in private ventures. Angel investing can be a great way to diversify away from equities and other investments. However, you should always view angel investment as a high risk/high return part of your portfolio and determine its overall weight with that in mind. Most experts recommend that you invest no more than 5% of your overall portfolio in alternative investments like angel investments.
So with all of the caveats out of the way, how do you actually become an angel? That’s a good question. First of all, in the U.S., you usually need to be an accredited investor, which means either:
- You have made $200k annually (or $300k combined with your spouse) for the past two years and expect to do the same this year.
- You currently have a net worth over $1 million, excluding your home
If you meet these criteria then you can move to the next step — actually finding quality deals and starting to evaluate potential investments.
Sourcing Quality Deals
Finding quality deal flow is harder than it sounds, especially when you’re starting out. Angel groups are a traditional route that many angel investors use to source deals. The angel group sources and evaluates deals collectively. Many angel groups are affiliated with major universities and / or professional groups and often have a particular investment focus. They meet regularly to evaluate companies and usually invest en masse when a deal is interesting to the group.
A more scalable way to source deals is through digital financing and crowdfunding sites, like Propel(x). Financing sites usually also have a focus, which can help you find deals based on your areas of interest. If you are interested in consumer goods and e-commerce then CircleUp would be a good place to start. If your passion is deep technology and companies pushing the technological envelope, then Propel(x) would be a good source. Both CircleUp and Propel(x) curate the companies on their respective platforms, providing higher-quality, pre-screened deals for you to consider.
Another way to improve both the quality of your deal flow and to improve the diligence of the deals is to connect with seasoned angel investors. Networking events or using funding groups are a good way to connect with these types of investors. Finally, online investing platforms also allow you to connect and interact with more seasoned angels. Like learning any skill (and this is an acquired skill) looking over someone’s shoulder is a great way to first get acquainted with the ins-and-outs of angel investing.
Actually making an investment: Consider an LLC
Now that you’ve sourced some interesting deals and are ready to invest, you have a couple of options. The first — and most expensive — is to make a direct investment in a company and meeting the minimum required by a company. Minimums are usually $25,000 and up, making diversification a challenge.
If you’re not ready to pony up the minimum but are still interested in investing then going with an LLC or syndicate may be a good way to get your feet wet. Many crowdfunding sites have created LLCs, including Propel(x).
LLCs are pooled investment vehicles that allow an accredited investor to invest smaller amounts — as low as $3000 on Propel(x). Investing through an LLC has the added advantage of allowing you to diversify by investing smaller amounts in more deals. LLCs also remove the administrative burden of angel investing and handle all of the logistics and administration. To learn more about LLCs check out this recent blog on the topic.
When it comes to evaluating a deal, we recommend following a process, which should include thorough due diligence. Here’s the process I follow:
- Is there a market for the product: Is this something that people would spend money for? How big is that market? A vast market is not required, but it should be reasonable sized – a few hundred million dollars at minimum for a high risk venture.
- Competition: What does the playing field look like? You want the field to be heavily tilted in favor of your possible investment.
- What does the company have that the competition does not have: IP? Trade secrets? Exclusive agreements
- Company exit strategy: Does the company have a reasonable plan for an exit? At the seed stage, “we’ll be going public” is not a reasonable plan for an exit.
- Financials: How much runway (cash in the bank/cash burned per month) does the company have? Will they be able to raise more money when required?
- Management: Is the company run by trustworthy and experienced entrepreneurs? There is often a premium for investing with a seasoned management team.
- IP – Is the technology or innovation a breakthrough? Has it been assessed by experts as a real and defensible leap forward?
Deal Terms and Documentation
- Convertible Note: These are the most common type of funding instruments for the seed round. Please see the July 1st blog post for more information on what to look for in a convertible note.
- Convertible Preferred Stock: This is a common form of funding that is often sought after the initial seed round. Preferred stock is often what the original investors convertible notes will mature to.
This list is by no means exhaustive and I’ll be going into further details about due diligence in future blog posts. However, this should give you a good overview of the steps to take when looking at a possible angel investment.
Bottom Line: Angel investing can be a rewarding (both mentally and financially) activity, but it is not for everyone. Angel investing is a great way to diversify part of your portfolio, to support ideas and entrepreneurs, and to earn a return.