Putting all of your eggs in one basket is rarely a good idea. This is especially true when deciding where to invest your money. Over the past fifty years, an increasing number of investors have ventured into what are referred to as “angel investments.” Generally speaking, angel investors fund the early stages of a privately held startup business where capital is low and uncertainty is high.
An estimated 90% of all new startups fail within a few years, and only 25% of those that survive make it to the 15-year mark. So, why consider angel investing? Well, one answer is diversification of investment risk. In other words, angel investing offers new opportunities to diversify your investment portfolio beyond traditional publicly traded securities. Angel investing can be a great way to support local entrepreneurs in your community or region and feel more connected to the companies in which you invest. Furthermore, high risk investments can translate to high rewards if the business succeeds.
If you have ever considered becoming an angel investor and are ready to take the plunge, here are a few tips to consider along the way:
- Utilize Local Angel Investor Networks. Choosing the right startup to invest in requires a critical eye. Belonging to an angel group not only gives you access to a larger range of diverse investment opportunities, but it allows you to review and vet potential investments with other successful investors. By leveraging the collective experience and expertise of your peers, you will be positioned to make more informed investment decisions.
- Look for Growth Potential. Look for key indicators of strong business systems. When it comes to angel investing, investors must predict which companies are likely to generate a profit within the next 3-5 years. With this sort of guessing-game, it is important to think about the upside potential of the startup founders and their business model. Ask the founders about their vision of the business and definition of success. To start, ask the following questions:
- How thoroughly have they studied their market?
- What type of competition exists and how will this company be different?
- How will they develop a profit-generating business, how long will take and at what cost?
- Get Legal and Accounting Advice. An attorney experienced in working with investors and small businesses can help you get a clearer picture of the investment both from a legal and a business perspective, while also offering valuable assistance with the drafting, review, and negotiation of investment documents. Complying with federal and state securities law is an important component of angel investing. Before deciding to invest, questions to consider asking your attorney include:
- What are some advantages and disadvantages of the investment I am considering?
- What rights do I have under the investment and governing documents of this company?
- How much personal protection do I have if the business is sued?
- Can I readily get out of this investment anytime I want?
- What red flags do you see and how can they be addressed (if at all)?**Similarly, there are just as many tax and accounting issues to consider when it comes to angel investing, go seeking input from your accountant is equally important.
- Paper the Deal. Every angel investment transaction should be properly documented in writing. And, if it is too good to be true, it probably is. Ensure that you have documents describing all material facts of the potential investment, including risks and downsides of investing. In general, state and federal securities laws require that all material facts be disclosed in connection with the offering of any security. Documentation is key, even if you are dealing with friends or family.
- Prepare to Lose. It should not come as a surprise that angel investing is highly speculative. There are significant risks that should be identified and understood before deciding to invest. Angel investments more often than not result in a loss, so you should not invest in small business startups if you need regular dividend income to cover monthly expenses or to fund your retirement. Angel investing requires patience and realistic expectations.
Angel investing can be a fun and effective investment strategy for investors who can afford to accept the risks, are prepared to do some extra due diligence, and have realistic expectations. Clearly, angel investing is not for everyone, but angel investing has become a valuable source of capital for the small business community. If you are looking for legal advice concerning a potential angel investment, please e-mail or call Eric Perkins at [email protected] or (804)205-5162.