Many people are interested in Angel Investing, either in being an angel or getting money from them. However, they are often confused about precisely what it is and how it works.

This is the first of a series of articles on Angel Investing covering everything you need to know to be a successful early-stage startup investor. It will also help founders better understand the people they are trying to raise money from.

As an entrepreneur, I raised millions of dollars from angel investors. Now I'm an active angel sitting on the BoD of the North Bay Angels and chairing their selection committee. I am responsible for picking the companies to present to the group.

What is Angel Investing?

Angel Investing is individuals putting their own money into startup companies.

Specifically, angel investors are not funds or venture capital companies. They are typically high net-worth individuals making personal investments into startups based on their judgment of their merits.

Traditionally you needed to have a lot of money to be an angel. Minimum investments started at $25k and often went much higher. These days crowdfunding and syndicates, topics I will cover in future articles, allow you to invest much smaller amounts, sometimes as little as a hundred dollars.

Because you are investing your own money, you are not responsible to anyone for your decisions. You are free to choose any criteria at all for picking companies. You might focus on a particular industry, issue, medical condition, or type of founder. Angels don't have to invest exclusively in companies with the potential for significant returns, but I suggest that should be part of your criteria, or you might not be an angel for very long.

Angel vs. Stockmarket

Like buying stock in the stock market, you are buying a percentage of the company. Unlike public companies, that percentage can be significant. If you invest $25,000 in a $1m (post-money) company, you will own 2.5% of the business. The same investment in Apple gives you 0.000001% of the company.

Another difference is angel investments are not liquid. You can't just sell your shares whenever you want. You need to wait for a "liquidity event," either an IPO or acquisition, which might not happen for a long time. My earliest investors had to wait thirteen years.

Angels also usually get a different kind of stock. In the public markets, you almost always buy common stock, while in startups, you want preferred stock, which provides additional rights and protections.

When investing in the earliest fundraising rounds, you usually don't receive stock but rather something that turns into stock later. It can be either a convertible note or a SAFE. These instruments require less legal paperwork and negotiation. You only need to agree on the value of the company and a few other details when making your investment and rely on a bigger investor in a later round to negotiate all the details of a full term sheet.

Angel Investable Companies

Not every small business is a good candidate for angel investment. Because you only get paid when the company exits in an IPO (rare) or acquisition, that needs to be the founder's objective. Someone starting a plumbing, construction, or restaurant business probably plans to run it for the foreseeable future, trapping your money with no prospect of returns. They are also unlikely to grow to be worth hundreds of millions of dollars.

These kinds of businesses can still be profitable investments, but they would need to be structured differently and pay returns throughout their lifetimes. I won't be talking about those kinds of investments.

Risk and Return

Compared to conventional assets, angel investing is incredibly high risk. Most angels see between 80% and 90% of their investments lose money, often returning nothing at all. It is also a long-term game. Even for the few companies that deliver substantial returns, you need to wait seven to ten (or more) years before you see anything. You can't sell the stock during that time, so you are trapped waiting to see what happens. If you get an answer quickly, it is usually because things went badly.

Don't invest any money you can't afford to lose or might need in the medium term. I have a fixed budget for angel investing alongside my safer investments. I never comingle those funds.

I'm not sharing all this gloom and doom to frighten you away from angel investing but to make sure you do so with your eyes open.

Investing in startups can generate fantastic returns. You should not consider deals without the potential to return at least twenty times your initial investment. The best deals can yield thousands of times your money.

However, those companies are rare. Intelligent angel investing is a statistical game. You need to make enough investments to have a good chance that some will become big winners. Those few home runs can offset the many failures to generate overall returns significantly better than the stock market.

The perfect strategy would be to only invest in future unicorns. However, I have not seen any reliable way to identify them, so for now, statistics are your friend. You need to make at least twenty investments to have a good chance of catching some big winners. Plan your investment sizes to ensure you can do that over the next ten or twenty years.

Ideal Angel Investments

Most angel investments are in very early-stage companies. They are typically pre-revenue or just starting to sell their solution. Often, they only have a prototype they are showing to potential customers.

I encourage angels to avoid investing in companies with ideas but nothing more. The risks are just too high. Most people who invest at the idea stage have a personal connection to the founders and invest more to help them than with any expectations of returns.

The angels I work with like to see companies valued between one and fifteen million dollars. That might seem low compared to some headline-grabbing deals, but it is typical of what I see at this stage.

I like to invest in companies that have created their solution and have identified an interested customer base. They need cash to accelerate sales & marketing and to flesh out or polish their product. I avoid companies where I have doubts that they can deliver a functional product at all. I don't like to fund science experiments.

Getting in the Game

One benefit of angel investing is working with these early-stage companies and motivated founders. I often describe angel investing as most of the fun of running a startup without the existential dread and 100-hour work weeks.

 If you buy stock in apple, they have zero interest in your input. At a startup, you may be able to help with advice, introductions, and even hands-on help. Many founders look for investors who can bring more than money to the table. They know the value of an intelligent and involved angel.

In the next few articles in this series, I will cover how to get started as an angel investor and dig deeper into the economics of early-stage investing and how that should impact your decision-making process.

Until next time, ciao!