For decades on Broadway, well-to-do patrons of theater would reach into their own pockets to back shows or talent they liked, giving productions a shot at success instead of facing failure even before opening night.
These rich theater patrons were called “angels,” and, in a 1978 paper on funding of entrepreneurs, University of New Hampshire professor William Wetzel broadened the term to describe investors willing to invest their own money into entrepreneurial companies.
Angel Investors and Modern Startups
In the world of startup companies, an angel is an early investor who can help bridge the gap between “friends and family” funding and a Series A funding with venture capitalists. While venture capitalists manage funds pooled from numerous investors, an angel is usually an individual who invests his or her own money. Sometimes, groups of angel investors work together on investment deals.
An angel investor may want to work with startups for more than monetary reasons. For example, an angel may be a retired executive who wants to stay involved in her industry, or a former entrepreneur who hopes to help out a new generation of startup founders.
Angels usually invest during seed rounds, and in amounts much smaller than venture capital investments. However, angel investors may also participate in pre-seed (aka “friends and family”) rounds as well. A typical angel investment is less than $100,000, while venture capital investments are frequently in the millions of dollars.
Angel Investors and Accredited Investors
Angels are almost always accredited investors, a term coined by the Securities and Exchange Commission (the “SEC”) that currently requires an individual:
- to have earned at least $200,000 (or $300,000 together with a spouse) in each of the previous two years, and expects the same for the current year; or
- has a net worth over $1 million, either alone or together with a spouse, excluding the value of their primary residence.
Under SEC law, only accredited investors can trade certain securities that are not registered with the SEC. According to the SEC, “One reason these offerings are limited to accredited investors is to ensure that all participating investors are financially sophisticated and able to fend for themselves or sustain the risk of loss, thus rendering unnecessary the protections that come from a registered offering.”
In November of 2020, the definition will be expanded to allow investors matching other criteria to be considered accredited. Startups cannot (and should not) afford the legal cost required to register their securities with the SEC, and so being an accredited investor is almost a prerequisite to being a startup angel investor.
What Angel Investors Expect
Like venture capitalists, angel investors will look for a high return on their investment to compensate for the high risk of investing in early stage companies. A return of 10 times the initial investment in less than 10 years (often much less) is not an uncommon expectation.
Angels also may be active participants in the startups they invest in, including requiring a seat on the board of directors as part of a deal. The addition of knowledge and experience may be welcome by a startup, but an angel investor is often the first outsider to work with a fledgling venture’s core team — and that can sometimes create company culture speed bumps.
What Taking on Angel Investments Means for Founders’ Equity
Because an angel investor receives a percentage of a company in exchange for the cash investment, the founders suffer “dilution”: a reduction of their ownership in the company. Although, on its face, an angel investment may appear a reasonable trade, founders need to also examine a deal in terms of future scenarios: what does this investment mean for a Series A round when we go after venture capitalists? What does this investment mean to the bottom line when we exit?
Wise founders will track and model outcomes of angel investments – and all other investments — in a good, up-to-date cap table. Without a cap table’s guidance, founders may not know until it’s too late that they took on too many angel investments and will end up losing control of their company after their Series A venture capital round.
Get a Great Cap Table and Learn More About Startup Economics
StartupProgram.com offers three cap tables that can track angel investments and model out the effect of those investments on founders’ shares from the moment the investment term sheet is signed all the way through potential exits. It’s absolutely essential that you fill out your cap table and model various scenarios before you start talking to angel investors.
With StartupProgram.com Academy, we’ll teach not only how to use the cap table, but all the economics and law behind properly forming and financing your company. If you know your equity position with your cap table and understand how venture economics works, you’ll be ready to negotiate with angel investors and venture capitalists from Day 1.