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      3. What’s an angel investor?

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      What’s in a Name?

      The term angel investor originated in the early twentieth century and referred to people who invested in Broadway shows, seeking a little glamour in their lives, along with a return on their investment—think The Producers, but the scrupulous version.

      Angel investors are individuals or groups of individuals who invest their own money in a new business. It is important to distinguish them from other types of investors, such as venture capitalists (see pages 15-18), who invest other people’s money.

      Angels provide funds for promising businesses, generally in the early stages of development. They typically invest at least $25,000, and sometimes much more, in fledging enterprises. Of course, others may also invest in your business—a rich friend or relative, for instance, may invest $5,000 or $10,000 to help you pursue your dream. But generally, these are not considered to be angel investors because their primary motive may not be a return on their financial investment.

      Angel investors expect to realize a significant—and relatively rapid—return on their investment. In return for their money, angels take partial ownership, or equity, of your company. Money from angels is not a loan. It does not need to be repaid if the business fails. Instead, angels will make their money back, ideally with substantial profits, when you sell the business, go public, merge with another company, or provide another way for them to take their money out (that is, a liquidity event). In some cases, angels may receive a piece of ongoing operating profits.

      Because angels expect a dramatic return in a relatively short period of time, they look for:

       The Right Time to Seek an Angel Investor Is When:

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      Money from Family and Friends

      If your wealthy father-in-law or best friend wants to invest in your start-up, it’s tempting to accept this readily available capital. But think carefully before you accept money from friends or family, especially if you also have the potential to raise money from outside angel investors. Not only may holiday dinners become very awkward if they lose their money, but having many small investors early in your company’s development can complicate later deals if you seek outside investors.

      What Do Angels Invest In?

      Angels invest in a broad array of businesses, from technology to medical equipment to software companies to business-to-business firms to online retail to restaurants to enterprises selling new inventions. In fact, angels invest in virtually every kind of business—as long as there’s a potential for significant financial returns. So whether you are the president of a technology start-up in New Jersey or an entrepreneur in Idaho with a smart idea for a new piece of farming equipment, there’s likely to be an angel investor in your backyard.

      Angel investors are interested in businesses that have the potential for substantial growth and are likely to produce hefty profit margins or to be an acquisition target within a few years. Because of this, industries with high growth potential have attracted the most angel investment. The chart on page 10 shows which industry sectors attracted the most angel investment in the U.S. in 2005.

      Since many angels made their money in high technology, and technology-based businesses have shown fast growth and rapid returns, a large percentage of angels are attracted to businesses that include a technological component in their concept or operation.

This isn’t to say that other types of businesses won’t catch an angel’s attention. It’s all in the business model. An attractive business is one that has a good chance of providing high financial returns for an investor, not just for the business owner. A corner coffee shop many provide a good income for its owner/operator, but for an angel to be interested in investing, it has to have a more ambitious business plan—perhaps one that includes creating a franchise operation. Stand-alone small businesses, even if their chances of success are good, typically do not generate the kind of financial returns that make them attractive to angel investors.

       Share of Angel Investment in the U.S. by Sector, 2005

      Source: Jeffrey E. Sohl, University of New Hampshire, Center for Venture Research