Business abounds with tales of investors appearing like angels for the last-minute rescue of new and, of course, ultimately successful companies. The shoestring struggle always reads like a page-turner, climaxing in riches for all. But the failure rate on angel investing is high. If you want to try it, here are some thoughts to help.
Angel investing can help diffuse many obstacles entrepreneurs face when seeking startup capital. And let’s face it, startups do sound thrilling as these visionary risk-takers invest immense amounts of creative energy, personal capital and sweat-equity in companies with unknown futures. Listening to them and sharing in this high-wire energy can be inspiring.
Many entrepreneurs, unable to secure bank loans for a new and unproven venture and after exhausting the interest of close friends and family, turn to angels. Some of these angel investments do very well. The angel investor who wrote the first check to Google’s founders saw a $1 billion return. But for every success, many angel investments sank from sight with businesses that never made it.
Angel investors, who put their own capital directly in companies, seem to enjoy business enthusiasm, long-term commitment and risk. Before you open your checkbook to a high-risk new venture, determine if you’re a good fit to become an angel investor.
So You Really Think You’re an Angel?
First, the SEC requires that most investors in startups be accredited, meeting one of the following conditions:
- Net worth, not counting your primary residence, of $1 million;
- Individual income of at least $200,000 in each of the last two years and a reasonable expectation for this to continue; and
- Joint income with a spouse of $300,000 in each of the last two years and a reasonable expectation for this to continue.
In the last few years, angel investing has organized. Most metropolitan areas have angel networks of 10 to 200 wealthy individuals who work as a collective and who often look for new investor members. Angels often organize syndicate deals, joining to invest with a lead investor who negotiates terms with the startup. The best investments get funded quickly and you’re more likely to be on the early side of this deal-flow if you network with other angels with strong reputations for providing funding.
Successful angels pass on hundreds of investment opportunities for each candidate they find worthy of investment. Any one venture faces low odds of succeeding, so consider diversifying your portfolio to spread the risk, just as in smart stock market investing.
Target a minimum $500,000 in allocations to your angel investments. One model: five $20,000 investments per year over five years, for a portfolio of 25 startups.
Diversification protects you only so much. Research paid for by two foundations supporting angel investing cited investment losses in 52% of the cases studied. Even when your investments do well your capital is often out of reach, as angel investments typically require illiquidity of five years or more.
Check Yourself First
The above SEC investor qualifications make a crude and potentially dangerous litmus test of your financial capacity to withstand losses in angel investing. A more customized approach begins by checking to see if you’re on track to meet your retirement goals. If your current and projected savings exceed what you require for the rest of your life, you have excess to angel invest.
The best angels also lend experience and influence to entrepreneurs and become business boosters. Retired entrepreneurs make some of the best angels for new companies in their field of expertise. Maybe a young entrepreneur just needs an introduction to an essential customer or advice to cut through the red tape of government contracts.
Those who stick with angel investing may also appreciate business factors beyond financial returns and reap a reward found on no spreadsheet. They can appreciate connecting with entrepreneurs and becoming, with each investment, a partner in the hopes and dreams of real people.
The opinions voiced in this material are for general information only and are not intended to provide specific advice or recommendations for any individual.
Investing involves risks including possible loss of principal. No investment strategy or risk management technique can guarantee return or eliminate risk in all market environments.
There is no guarantee that a diversified portfolio will enhance overall returns or outperform a non-diversified portfolio. Diversification does not protect against market risk.
All information is believed to be from reliable sources; however LPL Financial makes no representation as to its completeness or accuracy.
This article was prepared by FMeX.
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