Angel investors Law and Legal Definition

Angel investors are wealthy individuals who provide capital to help entrepreneurs and small businesses succeed. They are known as "angels" because they often invest in risky, unproven business ventures for which other sources of funds—such as bank loans and formal venture capital—are not available. New startup companies often turn to the private equity market for seed money because the formal equity market is reluctant to fund risky undertakings. In addition to their willingness to invest in a startup, angel investors may bring other assets to the partnership. They are often a source of encouragement, they may be mentors in how best to guide a new business through the startup phase and they are often willing to do this while staying out of the day-to-day management of the business.

Wealthy private investors provide American small businesses with the majority of their seed money. These individuals want to invest in up-and-coming new companies not only to earn money, but also to provide a resource that would have been helpful to them in the early stages of their own businesses. In many cases, the investors sit on the boards of the companies they fund and provide valuable, firsthand management advice.

Like other providers of venture capital, angel investors generally tend to invest in private startup companies with a high profit potential. In exchange for their funds, they usually require a percentage of equity ownership of the company and some measure of control over its strategic planning. Due to the highly speculative nature of their investments, angels eventually hope to achieve a high rate of return.

For many entrepreneurs, angels include friends, relatives, acquaintances, and business associates. Nearly 90 percent of small businesses are started with this type of financial help. Some entrepreneurs gain access to angel investors through venture capital networks—informal organizations that exist specifically to help small businesses connect with potential investors, and visa versa. The networks—which may take the form of computer databases or document clearinghouses—basically provide "matchmaking" services between people with good business ideas and people with money to invest.

In January 2004, the Angel Capital Association (ACA) was founded. It is a peer organization of angel investing groups from across North America. The ACA has a Web site that provides information about best practices and offers links to local angel investor groups.

TYPES OF ANGELS

Although an angel can seem like the answer for an entrepreneur who is desperate for capital, it is important to evaluate the person's motives for investing and need for involvement in the day-to-day operations of the business before entering into a deal. Knowing how to recruit the right angel, one who shares the entrepreneur's goals and objectives, and maintaining an open, communicative relationship with the angel can mean the difference between a solid financial foundation and a failing venture.

In an article for Entrepreneur, David R. Evanson and Art Beroff described several basic personality types that tend to characterize angel investors. "Corporate angels" are former executives from large companies who have been downsized or have taken early retirement. In many cases, these angels invest in only one company and hope to turn their investment into a paid position. "Entrepreneurial angels" are individuals who own and operate their own successful businesses. In many cases, they look to invest in companies that provide some sort of synergy with their own company. They rarely want to take an active role in management, but often can help strengthen a small business in indirect ways.

"Enthusiast angels" are older, independently wealthy individuals who invest as a hobby. As a result, they tend to invest small amounts in a number of different companies and not become overly involved in any of them. "Micromanagement angels," in contrast, usually invest a large amount in one company and then seek as much control over its operations as possible. "Professional angels" are individuals employed in a profession such as law, medicine, or accounting who tend to invest in companies related to their areas of expertise. They may be able to provide services to the company at a reduced fee, but they may also tend to be impatient investors. Evanson and Beroff stress that understanding the needs of various types of investors can help entrepreneurs to develop positive working relationships.

ANGEL GROUPS OR FUNDS

Although angel investors usually work on an individual basis there has been a trend towards the formation of angel investor groups within the last decade. These groups usually meet on a regular basis and invite prospective entrepreneurs to present their business ideas for consideration. David Worrell discusses what such a presentation may involve in his article entitled "Taking Flight: Angel Investors are Flocking Together to Your Advantage." If invited to present ideas before an angel investor group, "expect to be one of two or three presenters, each given 10 to 30 minutes to showcase an investment opportunity. Speak loudly, as most groups mix presentations with a meal."

Despite the potential for funding through an angel investor group, according to Worrell, individual angels are still likely to be the best source of seed and early stage money for a small business or startup. "Angel groups can bring more money and other resources, which makes them more effective at later stages."

AVOIDING POTENTIAL PROBLEMS

Regardless of the type of angel a small business owner is able to recruit, there are a number of methods available to help avoid potential problems in the relationship. Entrepreneurs should, for example, be very frank and honest when describing their business idea to a potential investor. Entrepreneurs should also interview potential investors to be sure that their goals, needs, and styles are a good fit with the small business. It is important to ask questions of potential investors and listen to their answers in order to gauge their needs and interests. Ideally, the angels' investment approach will be compatible with the entrepreneur's needs. A partnership between angels and entrepreneurs is much like a marriage involving issues of compatibility, cash, and shared goals.

SEE ALSO Venture Capital; Seed Money

BIBLIOGRAPHY

Angel Capital Association, January 2006, Available from http://www.angelcapitalassociation.org/. "About ACA."

Benjamin, Gerald A., and Joel Margulis. The Angel Investor's Handbook. Bloomberg Press, January 2001.

Chung, Joe. "Panning Out." Technology Review. October 2004.

Evanson, David R., and Art Beroff. "Heaven Sent: Seeking an Angel Investor? Here's How to Find a Match Made in Heaven." Entrepreneur. January 1998.

Gallagher, Kathleen. "Your Guide to Finding an Angel Investor." The Milwaukee Journal Sentinel. 4 July 2005.

Phalon, Richard. Forbes Greatest Investing Stories. John Wiley & Sons, April 2004.

Worrell, David. "Taking Flight: Angel Investors are Flocking Together to Your Advantage." Entrepreneur. October 2004.

                                 Hillstrom, Northern Lights

                                  updated by Magee, ECDI