An angel investor is usually a high net-worth individual who invests in early-stage start-ups in exchange for equity in the company. Angel investors are wealthy private investors focused on financing small business ventures in exchange for an equity stake. Unlike a venture capital firm, an angel investor invests their own capital during the early stages of a start-up when the risk of failure is relatively high, yet it might in the long-term unlock higher rates of return.
Understanding angel investors
Many angel investors have excess available funds and are looking for investment opportunities delivering a higher rate of return.
They tend to provide more favorable terms than other lenders because they invest in the person starting the business and not in the viability of the business itself.
Indeed, the angel investor may be a close friend or family member of the entrepreneur(s).
While the angel investor does want to make a profit, this outcome is secondary to helping the start-up transition through the difficult early stages of growth.
Essentially, they want to see the company survive long enough for a brilliant idea to come to fruition.
There are no formal requirements to becoming an angel investor, though many have gained accredited investor status from the Securities and Exchange Commission (SEC).
Why do entrepreneurs prefer angel investment funding?
To say that entrepreneurs require angel investment funding to keep the lights on would be too simplistic.
Many often require guidance on the most optimum way to spend the money to give the business the best chance of succeeding.
Entrepreneurs prefer to work with angel investors because they:
Offer wealth and knowledge
Angel investors have previous, first-hand experience of running successful enterprises.
Aside from their financial contribution, they mentor the entrepreneur to help them realize growth and higher rates of return.
Connect them with industry experts
Entrepreneurs can also gain access to the wide professional network of the angel investor.
These networks provide opportunities for further mentorship, but more importantly, can also provide the basis for subsequent rounds of investment funding.
Accept inherent risks
Most successful angel investments yield an internal rate of return (IRR) of 20-40% over a five to seven-year period.
While angel investing is inherently risky, angel investors seek to minimize risk by evaluating the idea against predetermined criteria.
These criteria may be based on industry knowledge, business model viability, the ability of the entrepreneur, and the time required to realize profit.
Angel investing vs venture capital
A venture capitalist generally invests in companies and startups which are still in a stage where their business model needs to be proved viable, or they need resources to scale up. Thus, those companies present high risks, but the potential for exponential growth. Therefore, venture capitalists look for startups that can bring a high ROI and high valuation multiples.
However, in angel investing, the angel usually invests in a very early stage, where there is no business model yet, traction, and revenue.
This of course will depend on the kind of investments the angel gets into, yet in general, angel investors try to look for those entrepreneurs with high potential.
The angel investor knows that many of her/his bets will go to zero, yet if they turn to work out, they might turn into 1000x winning bets.
That is why the angel investor looks more like a sports scout, finding talents very early on, than traditional investors.
The most successful angel investors today
Who are the individuals at the forefront of angel investing today? We have compiled a list of five of the most prominent below:
Fabrice Grinda
A French angel investor based in New York City who prefers to invest in marketplaces connecting buyers with sellers.
Grinda and a panel of experts are known to analyze approximately 100 companies every week. Some of his notable investments include Flexport, Betterment, and Alibaba.
Naval Ravikant
An Indian-American entrepreneur who began his angel investing journey with AngelList, a website connecting start-ups, angel investors, and job-seekers.
An American computer engineer and entrepreneur who is best known for creating Gmail and the original prototype of Google Adsense.
Buchheit is a partner in investment firm Y Combinator and manages his own angel investments in the media, information technology, health, and enterprise software industries.
Esther Dyson
A Swiss-born American investor, journalist, author, commentator, and philanthropist.
Dyson is a leading angel investor in the space, biotechnology, government, and healthcare industries.
She was an early investor in Facebook, Flickr, Space Adventures, Omada Health MeetUp, and Square.
Alexis Ohanian
An Armenian-American entrepreneur, investor, activist, and author who is passionate about the open internet, STEM education, and paid family leave.
Ohanian is best known for co-founding Reddit and was also a former partner of Y Combinator.
An angel investor is usually a high net-worth individual who invests in early-stage start-ups in exchange for equity in the company.
In addition to investment funding, angel investors provide expert guidance on how that funding should be optimized. Entrepreneurs value angel investors for their industry knowledge, professional networks, and high-risk tolerance.
Some of the notable angel investors today include Fabrice Grinda, Naval Ravikant, Paul Buchheit, Esther Dyson, and Alexis Ohanian.
The circle of competence describes a person’s natural competence in an area that matches their skills and abilities. Beyond this imaginary circle are skills and abilities that a person is naturally less competent at. The concept was popularised by Warren Buffett, who argued that investors should only invest in companies they know and understand. However, the circle of competence applies to any topic and indeed any individual.
Economic or market moats represent the long-term business defensibility. Or how long a business can retain its competitive advantage in the marketplace over the years. Warren Buffet who popularized the term “moat” referred to it as a share of mind, opposite to market share, as such it is the characteristic that all valuable brands have.
The Buffet Indicator is a measure of the total value of all publicly-traded stocks in a country divided by that country’s GDP. It’s a measure and ratio to evaluate whether a market is undervalued or overvalued. It’s one of Warren Buffet’s favorite measures as a warning that financial markets might be overvalued and riskier.
Venture capital is a form of investing skewed toward high-risk bets, that are likely to fail. Therefore venture capitalists look for higher returns. Indeed, venture capital is based on the power law, or the law for which a small number of bets will pay off big time for the larger numbers of low-return or investments that will go to zero. That is the whole premise of venture capital.
Foreign direct investment occurs when an individual or business purchases an interest of 10% or more in a company that operates in a different country. According to the International Monetary Fund (IMF), this percentage implies that the investor can influence or participate in the management of an enterprise. When the interest is less than 10%, on the other hand, the IMF simply defines it as a security that is part of a stock portfolio. Foreign direct investment (FDI), therefore, involves the purchase of an interest in a company by an entity that is located in another country.
Micro-investing is the process of investing small amounts of money regularly. The process of micro-investing involves small and sometimes irregular investments where the individual can set up recurring payments or invest a lump sum as cash becomes available.
Meme stocks are securities that go viral online and attract the attention of the younger generation of retail investors. Meme investing, therefore, is a bottom-up, community-driven approach to investing that positions itself as the antonym to Wall Street investing. Also, meme investing often looks at attractive opportunities with lower liquidity that might be easier to overtake, thus enabling wide speculation, as “meme investors” often look for disproportionate short-term returns.
Retail investing is the act of non-professional investors buying and selling securities for their own purposes. Retail investing has become popular with the rise of zero commissions digital platforms enabling anyone with small portfolio to trade.
Accredited investors are individuals or entities deemed sophisticated enough to purchase securities that are not bound by the laws that protect normal investors. These may encompass venture capital, angel investments, private equity funds, hedge funds, real estate investment funds, and specialty investment funds such as those related to cryptocurrency. Accredited investors, therefore, are individuals or entities permitted to invest in securities that are complex, opaque, loosely regulated, or otherwise unregistered with a financial authority.
Startup valuation describes a suite of methods used to value companies with little or no revenue. Therefore, startup valuation is the process of determining what a startup is worth. This value clarifies the company’s capacity to meet customer and investor expectations, achieve stated milestones, and use the new capital to grow.
Profit is the total income that a company generates from its operations. This includes money from sales, investments, and other income sources. In contrast, cash flow is the money that flows in and out of a company. This distinction is critical to understand as a profitable company might be short of cash and have liquidity crises.
Double-entry accounting is the foundation of modern financial accounting. It’s based on the accounting equation, where assets equal liabilities plus equity. That is the fundamental unit to build financial statements (balance sheet, income statement, and cash flow statement). The basic concept of double-entry is that a single transaction, to be recorded, will hit two accounts.
The purpose of the balance sheet is to report how the resources to run the operations of the business were acquired. The Balance Sheet helps to assess the financial risk of a business and the simplest way to describe it is given by the accounting equation (assets = liability + equity).
The income statement, together with the balance sheet and the cash flow statement is among the key financial statements to understand how companies perform at fundamental level. The income statement shows the revenues and costs for a period and whether the company runs at profit or loss (also called P&L statement).
The cash flow statement is the third main financial statement, together with income statement and the balance sheet. It helps to assess the liquidity of an organization by showing the cash balances coming from operations, investing and financing. The cash flow statement can be prepared with two separate methods: direct or indirect.
The capital structure shows how an organization financed its operations. Following the balance sheet structure, usually, assets of an organization can be built either by using equity or liability. Equity usually comprises endowment from shareholders and profit reserves. Where instead, liabilities can comprise either current (short-term debt) or non-current (long-term obligations).
Capital expenditure or capital expense represents the money spent toward things that can be classified as fixed asset, with a longer term value. As such they will be recorded under non-current assets, on the balance sheet, and they will be amortized over the years. The reduced value on the balance sheet is expensed through the profit and loss.
Financial statements help companies assess several aspects of the business, from profitability (income statement) to how assets are sourced (balance sheet), and cash inflows and outflows (cash flow statement). Financial statements are also mandatory to companies for tax purposes. They are also used by managers to assess the performance of the business.
Financial modeling involves the analysis of accounting, finance, and business data to predict future financial performance. Financial modeling is often used in valuation, which consists of estimating the value in dollar terms of a company based on several parameters. Some of the most common financial models comprise discounted cash flows, the M&A model, and the CCA model.
Business valuations involve a formal analysis of the key operational aspects of a business. A business valuation is an analysis used to determine the economic value of a business or company unit. It’s important to note that valuations are one part science and one part art. Analysts use professional judgment to consider the financial performance of a business with respect to local, national, or global economic conditions. They will also consider the total value of assets and liabilities, in addition to patented or proprietary technology.
A financial option is a contract, defined as a derivative drawing its value on a set of underlying variables (perhaps the volatility of the stock underlying the option). It comprises two parties (option writer and option buyer). This contract offers the right of the option holder to purchase the underlying asset at an agreed price.
Gennaro is the creator of FourWeekMBA, which reached about four million business people, comprising C-level executives, investors, analysts, product managers, and aspiring digital entrepreneurs in 2022 alone | He is also Director of Sales for a high-tech scaleup in the AI Industry | In 2012, Gennaro earned an International MBA with emphasis on Corporate Finance and Business Strategy.
