Angel Investors: Definition, Advantages and Disadvantages

Updated February 3, 2023

If you're in the early stages of a startup business, seeking funding from an angel investor can be a great way to obtain financing without taking on debt. Working with angel investors also gives you access to their knowledge and mentorship, which can be critical in the early years of business. Understanding both the advantages and disadvantages of obtaining this type of support can help you determine whether this route of financing is right for your business.

In this article, we discuss what angel investors are, discuss the advantages and disadvantages of this kind of backing and offer steps for how to raise these types of funds.

Key takeaways:

Angel investors provide capital for a startup in its earliest stages, typically in exchange for equity in the organization.
Angel investors can often provide support, expertise and mentorship, in addition to funds, for a business.
If you're seeking this type of investment, it's a good idea to create a comprehensive business plan.

What are angel investors?

An angel investor is an entity that provides capital to small startups or entrepreneurs, usually in exchange for equity in the company. The financial backing they provide may only be a one-time investment, or it could be ongoing financial support to help the new company in its early stages.

Angel investors are often looking for a higher return on their money than they could get if they were to invest in the stock market. They may also want to mentor a new generation of entrepreneurs or make use of their skills and experience in a new way.

Angel investors vs. venture capitalists

Both angel investors and venture capitalists fund startup companies, but they differ in a few key ways:

Whose money they invest: Unlike venture capitalists who invest other people's funds, angel investors usually invest their own money.
The amount of money they invest: Angel investors often add to the seed funding that a business owner already has from friends and family. Venture capitalists provide much more money and often assist bigger, more robust startups.
The degree of involvement they have in the company: While angel investors typically just fund an idea, venture capitalists usually fund a proof of concept and maintain much more involvement in business operations.

Types of angel investors

Angel investors are usually people who have gained an "accredited investor" status, although this credential isn't a requirement. An accredited investor is someone with a net worth of one million dollars or more in assets or someone who has earned at least $200,000 of income during the previous two years. It's important to note that someone who's an accredited investor isn't necessarily an angel investor.

Angel investor is a somewhat general term, and you can find this type of investor in many forms, including the following:

Friends and family: This is the most common source of funding for startups. Professionals starting their own business usually begin here when looking for financing.

Wealthy individuals: People who have a high net worth, such as doctors, lawyers or successful business people, are often willing to invest a large sum of money in exchange for equity in a business.

Groups: Many angel investors are increasingly starting to operate as part of a group. This raises the potential for the level of investment significantly.

Crowdfunding: This type of funding is becoming increasingly common. It involves having large groups of people invest small amounts of money online to reach a specific financial goal.

Advantages and disadvantages of angel investors

Here are some of the pros and cons of receiving funding through angel investors:

Advantages of angel investors

Angel investing could provide a business with the following advantages:

Less risk: When you receive funding from an angel investor, there's typically less risk than if you take out a small business loan. Unlike loans, you're not responsible for paying back the funding from an angel investor because they receive equity in exchange for financing.
Mentorship: Because angel investors have a lot of business experience, they can provide mentorship for the startup. They have the motivation to see the business succeed and can offer invaluable insight and guidance.
Credibility: When an angel investor supports a business, they endow that organization with credibility and reputability in the industry. They convey they believe the business could be successful, which can attract other investors and funding to the project.

Disadvantages of angel investors

Angel investing may involve the following disadvantages:

Less equity: While angel investors make it possible for business owners to get their startups running, they also get equity in the organization. Many business owners give away between 10% and 50% of their startups in exchange for funding.
Pressure: Angel investors may expect a substantial return on their investment, which can create additional pressure for you and any employees. Before accepting funding, evaluate whether the business can grow at the rate that an investor expects, and establish realistic expectations for growth.
Less control: After investing their money in a startup, most angel investors take a hands-on approach to the business. For example, experienced angel investors sometimes want to have an exit strategy in place, such as taking a business public or selling the company to a larger corporation.

How to raise funding from angel investors

If you're thinking about seeking or accepting angel investments, here are some steps you can take:

1. Develop a business plan

Before approaching someone about funding your startup or accepting funding from an angel investor, create a comprehensive business plan. This document can be useful whether you're obtaining funds from a lender or an investor.

Angel investors usually want to see a business plan that is both convincing and complete. Make sure to include financial projections, plans for how you want to market the business and specifics about the target market you plan to pursue.

2. Write clear terms

Put in writing what the investor is offering the business outside of funding because many angel investors expect to contribute their time actively to startups in which they invest.

This could mean acting as a mentor, taking a role as a manager or serving on the company's board of directors. While this additional involvement and the knowledge and experience you can gain are beneficial to the company, it's best to have the expectations in writing in advance.

3. Establish roles

It's essential to develop a clear understanding of the roles that each person has. The angel investor may have their own ideas for how to operate the business. By establishing roles in the beginning, you reduce the likelihood of a conflict at a later time.