What is an Angel Investor and What Motivates Angels to Invest?

The Benefits of Angel Investing

An angel investor is an individual who provides capital from their own funds to a private business, usually a startup. Angels often provide the first round of outside capital outside the founder’s family and friends. Angel capital may be in the form of straight debt, convertible debt, or equity purchases.

Why Do Angels Invest?

Angels invest in startups for various reasons, including the opportunity to earn a spectacular financial return. Many experienced angels (those who diversify their angel portfolios, negotiate fair deal terms, and conduct due diligence) routinely earn respectable returns in the neighborhood of 25% per year. A few occasionally do earn spectacular returns — along with many losses, duds, and liquidations.

Return on investment is not the only attraction of angel investing. There are also strategic and social reasons for investing in risky private securities. And, with the growth of equity crowdfunding since 2016,  those social motives have been more prevalent.

The Difference Between Angels and Venture Capitalists

Both angels and venture capitalists (VC) are possible sources of external capital for startup or early-stage companies, in addition to commercial banks, lenders, trade creditors, etc.

Differences in Typical Investments

Angels invest predominantly in companies in the seed, startup and early stages of development. However, some do invest in the later (expansion) stages as well.

VC firms attract funds from individual and institutional investors, who must be accredited investors. The fund manager uses those pooled funds to invest in portfolio companies, usually in the early stages and growth stages but sometimes dipping into the startup stage as well.

Investors investing money in a VC fund have no power to select portfolio companies, and they earn a return only after the fund manager takes a percentage of the capital gain (known as carried interest) plus a management fee.

Differences in Investment Portfolio Strategy

Private equity (PE) firms, hedge funds, and angel investors may have similar management and fee structures and are likewise only open to accredited investors, but their investment portfolio strategies differ:

• PE firms focus on acquiring outright (or buying controlling interest in) mature companies.
• Hedge funds use a broad range of investment strategies that often include both long and short positions.
• Angel investors make their own selections and invest directly in portfolio companies, focusing mainly on the startup and early stages and sometimes dipping into the seed stage.

Therefore, one of the benefits of angel investing is that angels earn 100% of any income or gains derived from the investment – no fees or carried interest.

Active Angels

According to various sources, the number of active angel investors in the United States has risen to more than 330,000, according to the American Capital Association.  In terms of dollars invested, angels, in the aggregate, generally invest much more than venture capitalists in the startup and early stages but much less than VCs in the expansion and later stages.

Before Rule 506(b), more than three-fourths of investors in angel deals were non-accredited. (Under Rule 506(b) of Regulation D, up to 35 investors in each offering can be non-accredited.) That proportion has likely changed as more issuers use the Rule 506(c) exemption because it allows general solicitation so long as non-accredited investors are excluded.

Angel Investing: Financial and Social Motivation

Certainly, one of the motives for investing in risky startups and early-stage companies is that investors can potentially earn a greater financial return than investing in public stocks, bonds, and mutual funds. However, ROI is seldom the only benefit of angel investing.

Some angels value the non-financial benefits of investing in private companies so much that it might be better to view their activity as consumption rather than as an investment, much as we look at the purchase of art or expensive homes.

Investment as Affinity for a Cause or Social Impact

Many angel investors also choose companies based on affinity. For example, a recent Harvard Business School survey found that female investors—a group slowly on the rise—are twice as likely to invest in businesses with a strong social impact or with female leadership. Furthering a social cause or empowering females in business is a non-financial reward that can be an integral part of the deal evaluation process.

Investment Motivated by Career or Community

Strategic investors often buy shares of growing companies because it allows them to make use of expertise they have developed in a particular industry or technology during their careers. Other motivations include learning about new technology before it reaches the marketplace and gaining entry into a company where they would like to be employed as an executive. Finally, many local investors want to support the community in which they live and work in order to encourage economic development.

Angel Investing In Terms of Dollars

In 2023, an estimated $5.7 billion was invested in angel and seed-stage deals, though the most active, early-stage investors have come from the accelerator Y-Combinator.

According to most data, a typical angel investment may be $25,000 to $50,000 per individual. Note that the average may be higher than the median because of a small number of very large investments. Remember that Title III equity crowdfunding facilitates much smaller investment amounts from a larger number of investors. Equity financing accounts for a portion of the capital raised from angel investors in a typical year. Debt financing accounts for another portion in terms of dollars. Some deals combine debt and equity.

The highest-profile angel investments have always been in technology startups, and the superstar angels tend to be located in high-tech communities. Indeed, the sectors with the most angel investment were the internet and healthcare.

Where’s The ROI On Angel Investing? It Depends.

Return on investment is not the only motive for investing in private securities, but it is one we can try to measure. The problem: ROI is an elusive statistic in the angel capital markets because issuers and investors are not required to report such data.

Statistics coming from academic studies can be taken out of context and distorted by the media. Survey results coming from professional associations are sometimes biased because they are promoting their members’ interests.

Band of Angels

The Band of Angels (BOA), founded in 1994, is one of the most successful angel groups in the United States, investing in around 20 deals per year since 1994. Most of its 165+ members (accredited investors only) are based in Silicon Valley. The Band reports 62 profitable M&A exits and 13 NASDAQ IPOs. The cumulative internal rate of return for all BOA investments over 20 years is a positive 53% per year.

While 53% is a phenomenal rate of return, Ian Sobieski, founder and managing director of the BOA, provided this caveat: “We’ve had more than 200 investments. If you take the top nine performing deals out of the basket, the IRR drops to zero. So, only one in 20 really moves the needle. Since the average investor invests in only 10-or-so deals, the odds of any one angel being in a winner are only 50 percent.”

The Value of an Angel Investor’s Time Spent

In surveys of angel investors, the estimated returns on investment tend to be overstated because they fail to consider the cost of investors’ time. Investors might spend considerable time before the sale sourcing deals, conducting due diligence and negotiating deal terms, and then continue advising or helping the founders post-transaction.

Some investments require more active involvement from angels than do others, but these are rarely passive investments. Equity crowdfunding is a whole new reality, however. It is quite unlikely that equity crowdfunding investors will be obligated or invited to participate in the operation or governance of the company, as we will explain further.

Angel Investor Returns Survey

Robert Wiltbank, Ph.D., is an associate professor of strategic management at Willamette University and an Angel Resource Institute (ARI) Fellow. He writes that “the best estimate of overall angel investor returns . . . is 2.5 times their investment . . . in [an average] time of about four years,” which yields a very respectable 26 percent annual return.

In 2012, Wiltbank described the results of his survey of individual angel investors. All surveyed are accredited and members of angel groups. In the survey, Wiltbank asked investors to disclose the financial results of their angel investments over a 15-year period. We must take into consideration that the respondents were self-selecting. We might hypothesize that investors who had lousy returns were less likely to respond to the survey.

Survey Findings 

In October 2012, based on his survey data, Wiltbank looked at more than 1,200 angel investments in the United States and the United Kingdom that resulted in what we call a termination event, where investors sold, redeemed, or forfeited their shares and realized a gain or loss. These events ranged from the company going out of business to an acquisition to an IPO.

Wiltbank reported that in any single investment, an angel investor was more likely to lose their money, though their returns were positive once their portfolio consisted of at least six investments. He also reported that angel investors in the United States and the United Kingdom produced a gross multiplier of 2.5x their investment in an average of about four years (an annual return of 26%). Keep in mind that Wiltbank’s survey only included accredited investors who belong to angel groups and did not account for time invested in researching and managing investments.

As a rule of thumb, “angel investors probably should look to make at least a dozen investments” to diversify their portfolios in terms of one or more of the following criteria.

• Industry or sector
• Geography
• Vintage
• Stage of development

Consider that 90% of all the cash returns are produced by 10% of the exits. This proportion applies to venture capital as well as angel capital.

Things to Keep in Mind

It’s worth noting that the survey results tend to represent investments by wealthy investors who target fast-growth and high-potential companies rather than companies that strive for steady long-term growth. The latter are probably underrepresented in Wiltbank’s data, as they are more likely to be rejected by angel groups (because of their longer exit horizon).

As such, they are more likely to filter down to equity crowdfunding as a path to financing. Rejection by angel groups does not necessarily make them bad investment opportunities. In fact, some of them may be less risky than the fast-growth startups that accredited investors chase. Although their returns may be less spectacular, they can yield income over a longer term, as well as a respectable capital gain.

Angel Investors: The Era of Equity Crowdfunding

The emergence of Title III equity crowdfunding creates a new class of angel investors for two reasons: the dollar amount of the commitment and the accessibility to average investors.

Amount of Funds Committed

Before the launch of equity crowdfunding, individual angel investors typically had to commit large sums of money to participate in an angel deal. This amounted to tens and sometimes hundreds of thousands of dollars. In return, investors received straight equity or convertible debt (debt securities that could be, under specific conditions, converted to equity securities). By contrast, through most Title III crowdfunding portals and broker-dealer platforms, investors can buy in for much smaller amounts — as little as $100 or less.

Accessibility to Average Investors

Next, this new class of crowd-angels is different based on access. Before equity crowdfunding, the average investor did not have easy access to private securities offerings. Angel deals were offered mainly to:

• Angel groups, whose members were accredited investors only.
• Professional angel investors who were known for writing checks to entrepreneurs.
• Strategic investors who worked in the same industry as the issuer.

Now, thanks to equity crowdfunding, many angel deals are aggregated on website portals and platforms for everyone to see, no matter who you know or don’t know.

Angel Groups and Angel Crowds

Considering the evidence, you would logically conclude that angel investors who belong to angel groups have an advantage over those who don’t. And since non-accredited investors are excluded from those groups, non-accredited angel investors are at a disadvantage.

However, equity crowdfunding creates a new kind of angel group to which all investors can belong and reap the benefits of angel investing: the crowd. The SEC declared in October 2013: “A premise of crowdfunding is that investors would rely, at least in part, on the collective wisdom of the crowd to make better-informed investment decisions,” which is why “we propose to require intermediaries to provide communication channels for issuers and investors to exchange information about the issuer and its offering.”

Collaboration with Other Crowdfunders

When you sign up for and become a member of an equity crowdfunding portal (or equity crowdfunding platform operated by a broker-dealer), you have the ability to collaborate with other members through three methods:

• Q&A forums where you can ask questions of issuers.
• Portals that enable crowd members to engage in discussions among themselves.
• Off-platform engagement and private discussions among crowd members.

Institutional investors (such as pension funds, university endowments, and banks) will seek to diversify, perhaps in an exploratory sense, by buying shares in early-stage companies, especially in the technology, consumer products, and real estate sectors. They have prodigious resources for conducting due diligence. If you are aware that an institutional investor is participating in a Q&A forum or discussion on a crowdfunding portal, pay close attention to their questions and comments.

As equity crowdfunding continues to develop and more non-accredited investors enter the market, the answer to the question: “What is an angel investor?” will continue to develop as well.

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We think you’ll also like:

• 4 Angel Investing Lessons from an Angel Group Veteran
• Evaluating Deal Terms in Crowdfunding Investments Part 1: Straight Equity
• How to Target Regulated Equity Crowdfunding Deals

[Editors’ Note: To learn more about this and related topics, you may want to attend the following on-demand webinars. You can view at your leisure, and each includes a comprehensive customer PowerPoint about the topic:

• Raising Capital: Negotiating with Potential Investors
• Crowdfunding from the Startup’s Perspective
• Dialogue on the Overall Due Diligence

This is an updated version of an article originally published on July 2nd, 2020.]

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