Investing in a new startup is always challenging, no matter who you are, because most of these ventures tend to fail even with proper funding. It is therefore crucial for a potential investor to choose the right formula to reduce the risks involved – and of course, make a lot of money!
Who is an angel investor?
An angel investor is any wealthy person who invests hundreds of thousands of dollars into a small or new business in return for equity in the business. He or she may be a well-to-do professional like a lawyer, doctor or engineer, but some angel investors are experienced entrepreneurs themselves.
An angel investor can also be referred to as a private investor, informal investor, business angel, angel funder or seed investor.
As an angel investor, you can fund the startup alone, which means a high profit if it succeeds. Alternatively, you can join a syndicate, which reduces your financial risk since you will invest less. Many angel investors opt to join leading syndicates like AngelList because they offer huge financial backing.
This article is meant as a guide to some of the factors you should consider to give you the best chance of succeeding as an angel investor.
You must be certified
International investors can use AngelList to back or fund syndicates based in America. However, potential angel investors must have enough money and meet certain other criteria.
To be accredited, you must have recorded earnings of $200,000 a year (or $300,000 together with your spouse) in the past two years. Alternatively, you can also qualify if you have a net worth of at least $1 million.
These requirements help to ensure that only capable investors are selected. Startup enterprises are characterized by huge financial risk and therefore only stable investors should become involved with them.
Identify the best startup
Most revolutionary business ideas began as startups, so you should always be on the lookout for the next big thing, even in a crowded market.
As a good angel investor, you should have an eye for the most viable ideas with regard to design, accessibility, ease of use, trends, communication with consumers, and so on.
Never put all your eggs in one basket, or all your money in one startup! As with any other investment, you are highly advised to spread the risk by investing in different projects. In a best-case scenario, the successful ventures will deliver you a net profit even after covering your losses on the failed ones.
Choose a syndicate
According to the business dictionary, a syndicate is a group of people or firms that come together to fund a business venture.
When choosing a syndicate, try to find one that matches your needs or is in the same field as you. You should also look at the syndicate’s history in terms of deals, leads, connections and the resources or facilities they have on offer.
Study the leads
Ongoing investors are not the only available leads; they can even be law professors like Jeff Schox from Stanford or Jenny Rooke, a venture capitalist.
Most of the leads are usually active or passive entrepreneurs. Since 2014, the FG Angels syndicate and Jason Calacanis have been involved in 33 and 11 investments respectively.
What to expect
The lead investor is responsible for informing the backers about new deals as they become available. If you like the deal and are ready to invest you can change your backing into a reservation; otherwise, you can choose to opt out of the deal altogether.
The backer is not bound by the switch from backing to reservation; however, if he or she opts out of a reserved deal, the lead investor can remove him or her from the syndicate.
Once enough reservations have been made, investors are summoned to close the deal. As a backer, you will sign documents that are administered by the lead investor. They will portray your investment as an LLC fund or in a nominee structure. This means that you will not be required to sign financing documents.
The idea behind creating the fund is to channel all the investors’ resources into one fund, which allows for ease of operation of the startup. The next step involves the investors closing the deal by transferring the capital to the fund.
Consider the carry fee
Investors, especially beginners, gain an opportunity to partner with other more experienced investors this way, but as you already know, everything good comes at a price. The investor is expected to part with a carry fee for the lead as well as a 5% fee charged by AngelList.
The carry fee is charged on the assumption that the lead investor will boost the deal by bringing valuable experience into the group. The lead investor’s carry fee is obtained from an extra percentage of any profit the syndicate makes.
You must understand how it works
In order to remain competitive, you must have a deep understanding of how syndicates work. A syndicate can contain more than 99 investors; however, only 99 can participate in a syndicated deal at the same time.
This means that if you see a great deal you must act swiftly in order to be part of it before other backers snatch it. This process normally takes around five days, or even less for an extremely good deal.
As you have seen above, angel investing can be quite risky, but it still has a good chance of profitability.
As a potential angel investor you can choose to join a syndicate in order to lower you financial risk while benefiting from working with experienced partners; or you can delve into it alone if you like being in total control of your investments.
This is a noble way to give back to the community by creating employment – not to mention the money you will make for yourself if you do it effectively!