Those who invest in assets like stocks, crypto, and real estate—know when they’ve made a profit: They sell the investment for more money than they paid for it.
Angel investors, typically wealthy individuals who back early-stage businesses with their own capital, don’t have such easy yardsticks. They put their money into a startup and bet it will succeed based on scant data and their own judgment.
But what do angel investors get in return for their financial support and guidance? This blog post delves deep into the various returns angel investors seek and receive, beyond just financial profits.
How Angel Investing Works
Angels typically consider lots of early-stage startups and whittle down their investment choices to a few. Then, they provide funding to their chosen startups to cover costs until the business starts growing. Angels typically invest $5,000 to $150,000 per startup. In return, they receive an equity stake in the company.
Investors and entrepreneurs may negotiate funding and equity details directly, especially in the earliest ventures. Investors also may use the company’s valuation to determine how much ownership to take.
Who are angel investors?
Angel investors are typically affluent individuals who provide capital for startups, often in exchange for ownership equity or convertible debt. Unlike venture capitalists, angel investors use their personal funds rather than pooled money from other investors. They often invest in the early stages of a startup, when the risk is highest but so is the potential for significant returns.
What Do Angel Investors Get in Return for Their Money
Angel investors get their payback through an exit that lets them liquidate their stake and potentially make a profit that’s based on the percentage of the business they own. Generally, investors will pre-plan the details of the exit when negotiating the term sheet before they invest in the startup.
See Also: Who is a Pre-Seed Angel Investor?
We will classify what the angel investors get in return for their money into:
- Financial returns
- Strategic influence and control
- Personal fulfillment
- Community and societal impact
Financial returns
1. Equity ownership
The most straightforward return that angel investors receive is equity ownership in the startups they invest in. When an angel investor provides capital to a startup, they typically receive a proportionate share of the company’s equity. This equity ownership represents a claim on the company’s future profits and a portion of the proceeds if the company is sold or goes public.
2. Capital gains
Capital gains are the primary financial motivation for many angel investors. If the startup grows and becomes successful, the value of the company’s equity can increase significantly. When the company is sold or goes public, the equity can be sold for a profit. Successful exits, where the company is acquired by another business or offers its shares to the public through an initial public offering (IPO), can yield substantial financial returns for angel investors.
3. Dividends
In some cases, startups may pay dividends to their shareholders. Dividends are a portion of the company’s profits distributed to shareholders on a regular basis, usually annually or quarterly. While many startups reinvest their profits to fuel growth rather than paying dividends, this can still be a source of financial return for angel investors in more mature or profitable ventures.
4. Convertible debt
Angel investors may also invest in startups using convertible debt. This type of investment involves providing a loan to the company with the option to convert the debt into equity at a later date, typically during a subsequent funding round. Convertible debt can offer the advantage of receiving interest payments while also retaining the potential for equity conversion and capital gains.
Strategic influence and control
1. Board and advisory roles
Many angel investors take an active role in the companies they invest in by joining the board of directors or serving as advisors. This involvement allows them to influence strategic decisions, guide the company’s direction, and leverage their expertise to help the startup succeed. Board seats and advisory roles also provide angel investors with a closer connection to the company’s operations and progress.
2. Mentorship opportunities
Beyond formal roles, angel investors often act as mentors to the entrepreneurs they invest in. They provide guidance, share their experiences, and offer valuable insights that can help founders navigate the challenges of building a business. This mentorship can be highly rewarding for angel investors, allowing them to see the direct impact of their advice and support on the startup’s growth and success.
Personal fulfillment
1. Supporting innovation
Angel investors frequently invest in startups because they are passionate about innovation and want to support groundbreaking ideas and technologies. By funding early-stage companies, they contribute to the development of new products, services, and business models that can potentially disrupt industries and improve lives. This sense of contributing to progress and innovation can be deeply fulfilling for angel investors.
2. Nurturing entrepreneurial talent
Many angel investors are former entrepreneurs who understand the challenges of starting and growing a business. They invest not only to achieve financial returns but also to nurture the next generation of entrepreneurs. Helping founders realize their visions and overcome obstacles can be a rewarding experience that goes beyond monetary gain.
3. Personal growth and learning
Angel investing offers a continuous learning experience. Each investment presents unique challenges and opportunities, requiring investors to stay informed about market trends, industry developments, and emerging technologies. This ongoing learning process can be intellectually stimulating and contribute to personal growth.
Societal impact
1. Economic development
Angel investments can have a significant impact on local and regional economies. By providing early-stage funding to startups, angel investors help create jobs, stimulate economic activity, and foster a culture of entrepreneurship. This economic development can lead to more vibrant communities and increased opportunities for individuals.
2. Social impact investing
Some angel investors focus on social impact investing, where they seek to support startups that aim to address social, environmental, or societal challenges. These investors prioritize companies that have a positive impact on the world, such as those working on sustainable energy solutions, education technology, healthcare innovations, or social justice initiatives. The return on these investments is measured not just in financial terms but also in the positive changes they help bring about.
3. Building a legacy
For many angel investors, their investments are part of building a legacy. By supporting startups that align with their values and vision for the future, they leave a lasting impact that can endure beyond their lifetimes. This legacy can be a powerful motivator, driving investors to support ventures that reflect their ideals and aspirations.
Risks Involved in Angel Investing
1. High failure rate
Despite the potential rewards, angel investing comes with significant risks. Startups have a high failure rate, and many angel investments do not result in financial returns. Angel investors must be prepared for the possibility of losing their entire investment and understand that success stories are the exception rather than the rule.
2. Illiquidity
Investments in startups are typically illiquid, meaning that it can be challenging to sell the equity before a significant liquidity event such as an acquisition or IPO. This illiquidity can tie up capital for extended periods, making it inaccessible for other investment opportunities.
3. Time and effort
Active involvement in startups requires a substantial time commitment. Serving on boards, providing mentorship, and assisting with strategic decisions can be demanding. Angel investors must balance these responsibilities with their other professional and personal commitments.
See Also: 200 Pre-seed Funding Companies That Can Fund Your Startup
4. Emotional investment
Angel investors often form close relationships with the founders and teams they support. The emotional investment in these relationships can be both rewarding and challenging, particularly if the startup encounters difficulties or fails. Managing these emotional dynamics is an essential aspect of being an effective angel investor.
Conclusion
Angel investors play a vital role in the startup ecosystem, providing the capital, mentorship, and resources necessary for new ventures to thrive. In return, they seek various forms of compensation, both financial and non-financial.
While the potential for substantial financial returns exists, the journey of angel investing is fraught with risks and challenges. So, by understanding these diverse returns and the associated risks, aspiring angel investors can make informed decisions and contribute meaningfully to the world of entrepreneurship.
In the ever-evolving landscape of startups, angel investing remains a dynamic and rewarding endeavor, offering the chance to be at the forefront of innovation while making a lasting impact on the future of business and society.
