Angel investing is a type of equity financing where an individual, known as an angel investor, invests capital in a start-up or early-stage company in exchange for equity ownership. Angel investors typically invest in companies that have high potential at their very early stages mainly because of the idea that the company has, the kind of problem they are solving, or the market segment they are in but are not yet established enough to attract venture capital or other forms of capital. In addition to providing funding for the startup to get off the ground, angel investors also provide guidance and mentorship to entrepreneurs, often leveraging their networks and industry expertise to help the company succeed.
How it works
Angel investing connects entrepreneurs with wealthy and experienced individuals interested in investing in early-stage companies. Angel investors can be individuals or groups who pool their resources to invest in a particular start-up. They typically invest their own money directly, or they can also invest through angel funds or syndicates. Once an angel investor has invested in a company, they become a part owner and can earn a return on their investment if the company is successful.
Benefits of Angel Investing
Potential for high returns on Investing: Angel investing presents an enticing opportunity for investors to earn substantial returns. Startups at the early stage have immense potential for rapid growth, offering investors the possibility of significant financial gains. Despite the high risk associated with angel investing, the potential for high returns remains a key attraction for investors. A notable example is the German engineer and entrepreneur Andy Bechtolsheim, who invested $100,000 in Google in 1998 before the company was incorporated. By 2010, his investment had grown to nearly $1.7bn, representing a return on investment of 1,699,000% and an annual return of 125% over 12 years. Similarly, local angel investor and LAN member Olumide Soyombo’s investment in Paystack saw significant returns when the company was acquired for $200m by Stripe in 2021.
Investing diversification: Angel investing in startups can offer a unique form of diversification from traditional investment vehicles such as bonds, equities, real estate, and foreign exchange (FX). While these conventional investments can provide investors with stable returns over the long term, angel investing, on the other hand, can allow investors to invest in early-stage companies with high growth potential, potentially yielding highly significant returns.
Opportunity to meet and work with talented and successful entrepreneurs: One of the key benefits of angel investing is the opportunity to work with entrepreneurs who are passionate about their business ideas and have a track record of success in their endeavors. Many angel investors are experienced entrepreneurs or business executives who can provide valuable mentorship and guidance to the startups in which they invest. By working closely with entrepreneurs, angel investors can help to identify potential challenges and opportunities, provide strategic advice, and help to build strong teams and networks. This can be particularly valuable for startups operating in competitive industries or facing significant regulatory or technological hurdles. Angel investors also have the opportunity to disrupt industries by investing in startups that are developing innovative products or services. By investing in disruptive technologies or business models, angel investors can help to drive innovation and create new markets. Chris Sacca, a renowned angel investor, offers a compelling illustration of the valuable role an angel investor can play in advising and connecting with startups. While employed at Google, Sacca commenced investing in startups as an angel investor, diversifying his investments into promising startups such as Uber and Twitter. Sacca’s extensive industry knowledge and active involvement in his portfolio companies enabled him to provide them with priceless advice, from enhancing user experience to raising capital and eventually selling their businesses. Moreover, Sacca’s vast network of contacts proved instrumental in helping his portfolio companies thrive and grow. Sacca’s investment in Uber yielded a remarkable return of over $36bn, while his investment in Twitter would later be valued at more than $5bn.
Potential for tax credits: Angel investors can enjoy tax credits in some countries, making early-stage startup investments more appealing. Recognizing the impact of angel investing on innovation and job creation, some governments provide tax incentives to encourage startup investment. The Nigerian Startup Act of 2022 is one such example, signed by President Muhammadu Buhari. The Act offers investors in designated startups a tax credit of up to 30% of their investment, which can offset any tax payable on the investment return. This tax credit should significantly motivate angel investors to invest in Nigerian startups. Another tax benefit of angel investing in Nigeria is the exemption of Capital Gains Tax. Under the Nigeria Startup Act 2022, angel investors (and other eligible investors) can dispose of labeled startup assets held in Nigeria for at least 24 months without paying capital gains tax. This means that angel investors can realize gains from their investment without paying capital gains tax.
What makes a good angel investor
As an angel investor, one can be part of a profitable new business’s growth while potentially earning a significant return on investment. However, only some are cut out to be angel investors, and those successful in this field typically share several key characteristics. Therefore, this essay will explore some qualities of a good angel investor.
Financial capacity is the first and most obvious requirement for being an angel investor. Investing in startups requires significant capital, and even a tiny investment can carry a substantial amount of risk. As such, a good angel investor needs to have sufficient financial resources to weather any potential losses and continue investing in promising new businesses.
Beyond financial resources, an angel investor should also have experience and expertise in the relevant industry. Startups often operate in niche areas, and investors who deeply understand the industry can help identify promising new businesses and provide valuable insights and advice to help those businesses succeed.
A good angel investor’s willingness to take risks is another essential characteristic. Of course, investing in startups is inherently risky, and there is no guarantee that any particular business will succeed. However, investors taking calculated risks and having a long-term perspective can often reap significant rewards when a startup succeeds.
Finally, a good angel investor should be able to provide value beyond just capital. Many startups seek more than just a financial investment; they also need guidance and support as they grow and develop. Angel investors who can provide valuable industry contacts, strategic advice, and other forms of support can be precious to startups and are more likely to see a return on their investment.
The process of angel investing.
Investing in startups is inherently risky, and angel investors must follow a well-defined process to minimize risk and maximize returns. Here are the processes involved in funding a potential startup.
Finding Potential Startups: The first step in the angel investing process is finding (often called sourcing in venture capital) potential startups to invest in. Angel investors can source potential startups in various ways, such as by attending pitch events, networking with other investors, and leveraging their personal or professional networks.
Evaluating Startups: After finding potential startups, the next step is to assess them thoroughly. Due diligence is an essential part of this process. It entails looking into the management team, finances, market opportunity, product or service offering, and firm rivals. Investors can evaluate an investment’s possible risks and returns with a rigorous due diligence process. The four stages of the due diligence process are legal, financial, market, and technological due diligence. Legal due process involves reviewing the startup’s legal records, including its articles of incorporation, prior shareholder agreements, and intellectual property filings. The financial due diligence examines the startup’s financial statements, estimates, and cash flow. Conducting market due diligence involves researching the potential market size, analyzing the competition, and identifying the target consumer demographic. Finally, the technical due diligence process scrutinizes the startup’s technology infrastructure, software code, and cybersecurity policies.
Negotiating Investment Terms: Once the due diligence process is complete and the startup is a good fit for the investor, angel investors can negotiate investment terms with the startup; this typically involves drafting a term sheet and a Simple Agreement for Future Equity (SAFE). A term sheet outlines the key terms of the investment, such as the valuation, equity ownership, liquidation preference, and investor rights. A SAFE is a more straightforward document that allows investors to invest in a startup in exchange for the right to receive equity at a future date when a trigger event occurs, such as a future funding round or an acquisition.
Closing the Deal and Providing Ongoing Support: After negotiating investment terms, the final step is to close the deal. This involves signing the investment documents and wiring the funds to the startup. Angel investors should also provide ongoing support to the startup by offering advice, introducing them to potential customers or investors, and helping them navigate future funding rounds.
Angel investors are a critical component of the technology ecosystem, providing much-needed funding, expertise, and guidance to early-stage startups. As such, they play an essential role in helping to drive innovation and promote the growth of the tech industry and the economy.
For more information on the risks involved in angel investing, you can listen to this panel attended by LAN’s Executive Director, who gives a bit more insight. If you’d like to be a part of the foremost angel investing network in Nigeria, you can apply using this link.
