What is an Angel?

One concept interested investors wonder about is angel investing.  It is not clear what “angel” is all about.  There is a textbook definition at Wikipedia.  The textbook definition always has exceptions.  Surely, to be a member of an angel group, you need to be what the IRS defines as an accredited investor.  But before accredited investors get involved, usually the entrepreneur has used their own funds, and gone to their friends and family.  

It is almost a linear path for a scalable business.  Entrepreneur has an idea.  They play with it.  Then, they invest some time and their own cash to see if they have anything.  A little success, and they share the idea with family and/or friends.  Those people put some money to work.  If the idea starts to take shape and show promise, the business starts to take off.  

This inflection point is critical.  When the business starts to grow, the entrepreneur needs to make a decision.  They may be able to run a nice “lifestyle business” that pays them and their employees a decent income.  They provide a necessary service to their customers, and survive until the entrepreneur wants to pass the business along to someone else, or sell the business to someone.  Sometimes though, that business is scalable.  Given a little capital, it might become disruptive to the marketplace.  One person’s idea of a cookie shop is someone else’s Mrs. Field’s Cookies.   Knowing if you have that type of business, or even want that kind of business, will determine what you do when you hit that inflection point.

When angels come in, the business has usually proven its concept.  It is growing, and the entrepreneur sees a much bigger market potential.  The business might not even have much cash flow, and certainly many of them are not cash flow positive!  You are ready to grow and angels are ready to make the leap of faith so you can.    

Some people think angels invest massive sums of capital into companies and take really big risks.  Some do.  But most don’t.  They invest a little risk capital into a lot of different companies.  This diversifies risk for the angel.  Occasionally, that small investment they make turns into something monstrous.  Google was started with a  $100,000 investment!  Many times what you see is a company asking for $500,000 in start up capital and many many angels participating with investments of different amounts.  They do it over and over.  In 2008, angels invested $19 Billion of their own capital in different little companies all over the US.    

Ideally, the angel doesn’t just write a check.  The money is necessary, but that start up needs something more.  The angel generally will use their own personal network to help that company make connections and improve its business.  Many times, the angel will have deep experience in the industry, and can advise the entrepreneur in order to avoid common pot holes and pitfalls that all start ups hit on the road to success.  So, not only is the angel a financier, they are a mentor.  

Picking your angel group is important too.  Different groups have different requirements for their members.  It’s a lot of work running a group.  As Milton Friedman said, “there is no free lunch”.   That applies to angel groups too.  Groups are all free to structure whatever way they want, but generally they have one basic structure.  There is screening of deals, presenting of deals and investing in deals.  If you want to be an angel, be prepared to do a little something somewhere in your group.  It makes the group run better, and it’s energizing interacting with other angels in your group.  

The average time that angels are in the investment varies as well.  The rule of thumb though is that most angel investments will take 5-7 years to play out.  Companies that are early stage are getting their footing.  Once that footing is found, growth can be explosive.  That is why no matter what business plan an angel sees, every revenue graph of every business looks like Al Gore’s hockey stick graph!  But in this case, it’s not temperature rising, it’s revenue and profits.  

The angel always has an eye out exit of the investment.  Good angels are not interested in getting a dividend quarterly from the company in perpetuity. They want to see profits reinvested for growth.  Money is made when the company is acquired by another entity.  
Less than .05% of all angel investments go to an initial public offering (IPO) on an exchange. Angels don’t look forward to ringing the opening bell at the NYSE.  They do look forward to signing acquisition papers in a lawyers office!  

Hopefully, this gives you a good overview of what the angel does and who they are.  If you have anything to add, please comment in the comments section on the blog.  

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