Angel Investors: How the Angel Investment Process Works

An angel investor is an individual who invests in early-stage business startups or small businesses, providing capital and crowdfunding for its expansion in exchange for equity in the company. Angel investors are sometimes referred to as accredited investors. Both labels connote a high net-worth individual; however, according to the Securities and Exchange Commission (SEC), accredited investors are defined by a net worth of one million dollars in assets or more. Non-established businesses with insufficient cash flow commonly utilize angel investing, which can provide much-needed cash infusions to help them down the path toward profitability.

The term “angel,” in reference to this specific type of investor, was coined by William Wetzel, a University of New Hampshire professor and founder of the Center for Venture Research. In 1978, Wetzel conducted a study on seed capital fundraising by entrepreneurs in the United States. Within this study, he used the term angel when referring to the investors.

The term “angel” also has roots in the Broadway theater scene, where it was used to reference wealthy individuals who provided funding for productions that would have otherwise been canceled. Today, angel investors exist as a vital part of startup existence and centerpiece of funding.

Angel investors do not have a set amount of money to contribute to a start-up business: Investments can range from a few thousand dollars to a few million dollars. Research has shown that angel funding is directly correlated with a higher survival rate for startups. Here’s a closer look at how angel investments work:

• Investors identify investment opportunities. Angel investors or angel groups typically lean into startups revolving around healthcare, telecommunications, consumer products and services, electronics, and utilities. Before getting started, angel investors often need to build their access and entry points to exciting companies and grow their reputation amongst founders. Once established as a successful angel, either through more experience or by becoming part of an established angel group, deals begin to happen.
• Screening process. As the first checkpoint, angels go through a screening (or scouting) process where they separate the companies they want to work with from the ones they don’t. Angel investors look for higher return rates (around 25 to 60 percent) than what they would typically receive from traditional investments.
• Startups pitch potential investors. Most angels need to know a team and their story intimately before making any investment decisions. A business pitch is a presentation in which entrepreneurs give a brief overview of their business, financial needs, and ultimate goals to a group of investors to sell their idea. Pitches can range from an informal lunch meeting to an office presentation with a slideshow.
• Investors review the pitch. After a pitch, angel investors will regroup to review the presentation materials and other pertinent information. This process involves asking lots of follow-up questions, anticipating any challenges, reviewing the business plan, and modeling. Sometimes networked groups will prepare a formal due diligence report with a checklist of issues they want to address.
• Both parties connect to establish terms. If a deal is shaping up successfully, the angel or angel group manager will connect with the entrepreneurs about prospective deal terms. At this stage, they discuss points such as valuation, deal flow, and deal structure. The end goal is to negotiate a mutually acceptable set of terms documented via a term sheet, a non-binding document that outlines the deal’s major components, and a diligence report.
• Filling the round. While the terms are being worked out, it’s essential to gauge how much an investor wants to contribute and any additional money the business may need. This step, known as deal syndication, involves the entrepreneur and lead investor joining forces to bring in investors as quickly as possible. Since it is too costly and time-consuming to renegotiate the deal at every point in the investment process, there must be alignment amongst investors and the management team.
• Closing the deal. In preparation for closing, lawyers will need to draft definitive legal documents before any money can exchange hands. Legal counsel can usually pull together deal documents relatively quickly, ranging from one to two weeks, depending on the deal’s size. Once everyone has signed off on the agreement in its closing package, angel investors can begin offering mentorship, make introductions, offer board advice, and sometimes board service.

The main difference between angel investors and venture capitalists lies in their financial sources and the number of companies in which they invest.

• Angel investors use their own money. Angel investors are often retired entrepreneurs or executives who want to remain involved in burgeoning businesses, foster emerging entrepreneurs’ growth, or invest in early-stage companies. Unlike venture capitalists, who manage investment funds that consist of pooled money from various individuals via venture capital firms, angel investors invest with their own money.
• Venture capitalists invest in fewer companies. On an annual basis, angel investments in the United States are almost equivalent to the combined value of all domestic venture capital funds. The difference between the two is that angel investors invest in 60 times more companies than venture capital funds.

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