New businesses have to look for capital in a variety of places. When people who start new businesses have exhausted the usual methods — their own funds, and loans obtained from friends and family — they still may not be able to get bank loans or venture capital funds. This is when businesses look for an angel investor. An angel investor uses his or her own private funds to add to the capital needed to start a business in exchange for a fairly large share of ownership in the company, usually between 10-30%.
The angel investor is making a very high-risk investment, so he or she often looks for companies that have a reasonable expectation of returning about 10 times their investments within five years. Some look for companies that might return as much as 20 to 30 times an investment. Often angel investment only offers about 20-30% profit on advanced capital, but this profit is still considerable.
Usually the angel investor diversifies by investing in more than one start up company, because there is a high failure rate for many new companies. This is why advancing one’s own money is considered high risk. Some new businesses are bound to fail, and when this occurs, any money loaned by the angel investor will be lost. Usually a person who wants to be an angel investor has money to lose, which can be considered a tax write-off in many cases. But the potential big payoff for an investment exists and offers a fairly good opportunity to make a considerable profit.
An angel investor might also have considerable business acumen, and give advice to a start-up company on how to be most successful. He or she does this because it’s helpful to the company, and also in the best interest of the investor. A successful company means a higher rate of return on investment.
Like venture capitalists, many angel investors now belong to groups where they pool funds together. Angel investor organizations make joint decisions about the best places to spend money. This can mean fewer new companies can find an angel investor. The screening process for obtaining one can be quite vigorous, and only about 1% of new businesses in the US are able to convince an angel investor to advance funds for their companies. This is still a higher rate than those companies that are able to receive venture capital funds, which is only about a quarter of a percent of all who apply.
An angel investor will extract the most money or ownership of portions of the company for his investment. This represents the most expensive way to get startup money for a company. Yet it is often the only way to get the necessary funding to begin a company, since venture capitalists may not be willing to invest, and few banks are willing to lose their shirts on newly founded businesses.
The angel investor justifies their high return if the company profits by saying his or her investment is at the highest risk for being completely lost. This is true, but it’s not exactly angelic, as most modern people would see it. Instead it's risky investing that offers the possibility of making a great deal of money.