What is angel investing?

angel investor

Angel investor Pip Wilson takes us back to basics and explains what exactly angel investing is.

The use of the word “angel” to describe an investor began in the early 20th century on Broadway, where wealthy individuals would provide financial support for theatrical productions that would otherwise have to be shut down. Since the 1970s, the term has been applied to any individual who invests in a company in return for equity. Sometimes these individual angel investors form groups and invest as a collective unit.

When people think of angel investors in Silicon Valley, for example, they often think of people like Ashton Kutcher, a man already famous as a TV and film actor who nevertheless has built up a portfolio worth hundreds of millions by investing in companies such as Uber and Airbnb.

But angel investors come in many shapes and sizes and put money into companies for many reasons. The most patent is a desire to achieve much greater returns than they would from more traditional investments such as stocks and shares. In many countries there are also tax incentives for would-be angels. In the UK, angel investors benefit from schemes such as Enterprise Investment Scheme (EIS) or Seed Enterprise Investment Scheme (SEIS) which offer tax relief for qualifying investments.

Adding value

There is also a real perceptible excitement that comes from making a sizeable financial contribution to a growing business. This is hugely appealing to investors and shouldn’t be underestimated. Unlike “traditional” investing, angel investing is often active, not passive. Investors have the opportunity to influence events in companies and can add value by offering introductions or advice. They have the added benefit of learning the business while being removed from the more detailed day-to-day processes.

Thanks to popular TV programmes like Dragons’ Den and the wild success of some angel-investor-funded SMEs in the tech sector, angel investment is growing in popularity and in the public understanding. The profile of the angel investor is also changing: increasingly, younger investors and female investors are interested in angel investing and in doing so offer different perspectives and experience to the companies of tomorrow. Though this is encouraging, a survey commissioned by the UK Business Angels Association and Centre for Entrepreneurs in 2015 found that only 14% of angel investors are women. Clearly there is still room for improvement.

What angel investing represents is more interesting. Unlike venture capitalism, whereby individuals invest the pooled money of others in a fund, angel investing implies a more personal connection. Angels tend to invest between £10,000 and £100,000 into a startup, whereas a venture capital firm will frequently invest north of £1m.

While there are angel investors who are only focused on the financial returns, there are others – especially those who were or still are entrepreneurs themselves – who look at different factors or are otherwise willing to take a risk because their goals are altruistic. This might include a desire to help emergent entrepreneurs, businesses that will have a social impact, or those that will create jobs in the long term.

The expression that is often used in the context of venture capitalist firms is “race to exit”. For venture capitalists, the goal is to invest money in a company, make as much as they can in return and then leave the company at the right time. Angel investors want to make money, of course, but even those that aren’t investing for altruistic or partly altruistic reasons have a deeper and more personal relationship with the company. It’s their money that they’re risking and so their attention is more focused and long term.

Gaining traction

Entrepreneurs seeking investment and wondering where to start might look to angel investors over VC firms so that they don’t become just another asset in a huge portfolio. In fact, for starting entrepreneurs, raising funds through angel investment is an excellent way to prove their concept and to gain traction. It depends on the business, but in some cases the money raised by angel investors can be enough to make the business profitable or raise its valuation to such a level that the business owner is ready to raise VC funds.

It’s important to note – and this point should not be under-appreciated – that angel investment requires expertise and an ability to bear financial risk. Angel investing is therefore restricted to those with a certain amount of knowledge and a certain level of income.

Before joining a syndicate or becoming an angel, potential investors need to become self-certified as a High Net Worth individual (as defined by the FCA under the Financial Services and Markets Act 2000). Even if they are wealthy individuals, that is no guarantee that they have the knowledge and attitude to become an angel investor. AngelList founder Naval Ravikant, whose network connects startups with angel investors, said at a CNET panel that he had turned away more than 8,000 potential investors in two years because, among other factors, they were not “sophisticated investors”.

What is sure, however, is that whether you are an investor driven in pursuit of a cause, an enthusiast for a sector or subject or a financial backer who wants to take a more hands-on approach, angel investing brings with it fantastic opportunities to help exciting new ventures.