Angel Investor

An angel investor is a wealthy individual who invests their own money in early-stage businesses, usually in exchange for a share of ownership or a right to future shares. Angels typically back companies at the very start, sometimes when there is little more than a founding team and an idea, and before institutional venture capital funds will invest. Many are former founders or executives who also offer advice, contacts and credibility.

Angel investing sits at the earliest end of private markets, followed by seed funds, venture capital and later private equity. In the United States most angels must be an accredited investor to take part in private offerings. Angels may invest alone, through syndicates led by an experienced investor, or through organised angel groups and online platforms.

Picture a friend of the family who has done well in business and decides to help a young baker open her first shop. He gives her money to get started and, in return, owns a slice of the bakery. If it grows into a chain, his slice could be worth many times what he put in. If it closes, he loses the lot.

That is what angels do for start-ups. They take a big risk early, when banks will not lend and larger investors are not interested, and they hope a few big winners make up for the many businesses that do not survive.

A typical angel deal follows a familiar path. The entrepreneur pitches, often with a deck and an early product or minimum viable product. The angel carries out due diligence on the team, market and terms, usually lighter than a fund's. If both agree, they sign documents, the angel wires the money and the investment is recorded in the company's capitalisation table. Investment sizes vary widely, from a few thousand dollars to several hundred thousand, and angels often spread money across many companies, accepting that most will fail.

• Priced equity. The angel buys shares at an agreed valuation, documented in a term sheet and share purchase agreement.
• SAFE. The simple agreement for future equity, introduced by Y Combinator in 2013, gives the right to shares in a later round, usually with a valuation cap or discount.
• Convertible note. A convertible note is a short-term loan that converts into equity at the next round, typically with interest and a cap.
• Advance subscription agreements. A UK structure in which money is paid now for shares issued later.

SAFEs and notes let founders and angels avoid agreeing a valuation too early, but they can lead to surprising dilution when they convert.

Securities laws govern who can invest in private companies and how deals can be marketed. In the US, Regulation D limits most private offerings to accredited investors, while Regulation Crowdfunding allows smaller amounts from the public, a form of equity crowdfunding. Several countries encourage angel investment through tax relief. The UK's Enterprise Investment Scheme, introduced in 1994, and Seed Enterprise Investment Scheme, introduced in 2012, give income tax relief and capital gains benefits to individuals investing in qualifying small companies. Other countries offer credits, deductions or co-investment funds.

Crypto has its own angel culture. Individual investors, often early holders or founders of successful projects, back new protocols through equity, token warrants or allocations in a token pre-sale. Token deals typically include vesting schedules and lock-ups, but because tokens can trade publicly much sooner than start-up shares, angels may be able to sell earlier, which raises questions about alignment with retail buyers. Crypto angels also face securities law uncertainty over whether the tokens they receive are investment contracts.

Angel investing is highly risky. Many start-ups fail, and returns are typically driven by a small number of large successes. Investments are illiquid: money can be locked up for many years with no market to sell, and later funding rounds may dilute early holders. Information is limited and valuations are hard to judge. Experienced angels manage these risks through diversification across many companies, investing only money they can afford to lose, co-investing with others and reserving funds for follow-on rounds. Founders, for their part, weigh the value of an angel's advice and network against the control and equity they give up.