This post is written in partnership with Hustle Fund's Angel Squad.
In 2010, two angel investors named Mike Walsh and Oren Michaels invested $5k each into the seed round of nascent transportation startup UberCab. 9 years later, after Uber went public, their $5k investments were valued at $24.8M apiece.
Stories like this are what make angel investing so appealing. Many of the top companies on the S&P 500 today started as venture-backed startups. Angel investors put money into startups in hopes that one becomes the next Apple, Amazon, or Uber.
You might think you already need to be flush with cash in order to become an angel investor, but that’s just not true. You can angel invest with as little as $1,000. Since it is so accessible, becoming a successful angel investor requires more than just having the money. In a world where 7 of 10 startups don’t return any investment, knowing how to see and pick the right deals is everything. To help new angels get started, our friends at Hustle Fund created a free Angel Investing Starter Kit here >>>. We think you’ll like it.
What is an angel investor?
Let’s start with the basics. An angel investor is someone who invests their own money in privately-held companies. In the technology world, angel investors typically provide seed funding to early-stage startups. They’re willing to take on higher risks for the potential of significantly higher returns.
Along with capital, angel investors often provide their companies with guidance and introductions to clients, employees, and other investors.
Who can become an angel investor?
Regulators attempt to limit access to early stage investments by making investors meet a certain standard of know-how and financial sophistication. For angel investors, this means meeting the accredited investor designation.
An accredited investor is an individual who meets one of the following requirements:
- Individual or joint net worth in excess of $1M (not including the value of a primary residence);
- Individual income in excess of $200k or joint income in excess of $300k for the two most recent years, with a reasonable expectation of reaching this level in the current year;
- Holding a Series 7, 62, or 65 license (Hustle Fund’s Angel Squad pays members’ Series 65 exam fee and offers a community support group to help people study). Note to be accredited via licensure also requires the individual to register with either the state or SEC as an Investment Advisor Representative for a Registered Investment Advisor (RIA). The RIA can be the individual's own firm.
Developing your approach
Assuming you meet legal requirements, the next step is to formulate your framework around investing. Here are some steps you should consider taking:
Understand the risks of angel investing
As previously mentioned, early-stage startups are high-risk investments. Most angel investors understand and accept the possibility that they’ll likely lose all the money invested in any given deal. That’s because—as our Uber example showed—it only takes 1-2 successful investments for angel investors to make all their money back, and then some.
You should also be prepared to wait a while to see a return. Early stage investments are often locked up for a very long time.
On the flip side, the benefits of angel investing are the potential for high returns as well as getting to influence outcomes at the companies that you invest in.
Use an investment framework
An investment framework allows you to take an objective look at an opportunity and decide whether the investment is right for you. As an angel investor, how you evaluate should be derived from your own research and understanding of the market, areas of interest, and financial situation.
Hustle Fund’s Framework
When you’re just starting out, it can be helpful to leverage a tried and true investment framework. We like Hustle Fund’s for its simplicity and getting to the core of what matters in the success of an early stage startup. Here’s what they use to assess deals:
- Team: do you believe the founding team has what it takes to win in the market?
- Solution: how differentiated is the product/service?
- Market: how large is the market?
- Execution: how is the startup currently performing? Do they move quickly?
- Fundraise-ability: do you believe the founders will be able to successfully raise in future rounds?
As you see more deals, you should begin to “pattern match” the characteristics of a good deal. You just need to look at a lot of deals!
Win allocation
We describe allocation as something angel investors have to “win” because, if a deal is worth investing in, chances are the founders aren’t having trouble finding suitors. While a good brand and reputation can get you in the room, winning allocation as a newbie angel investor also requires some degree of cooperation.
Founders generally set aside a certain portion of the fundraise for small checks from angel investors, but all must invest on similar terms, and don’t get much say by way of valuation or control. This is mostly a function of leverage—your small check isn’t going to move the needle too much for the business. Founders will offer angel investors allocation because they believe having them on the cap table will be a value-add for the business, but they expect them to be flexible in negotiation.
As such, you should aim to set expectations with founders around your investment process, including the number of meetings you require, and the amount of access you need to make a decision. Being transparent allows founders to decide if they want to go through with your process.
Set your budget
If you're just starting out, investing as little as $1k in deals can be a great way to earn more allocations (because founders can usually make room for very small checks, given the investor is a value-add), test your investment thesis, and fund more companies. Understand your financial situation, and set aside a budget for how much you’re willing to invest as an angel investor.
Build a diversified portfolio
To mitigate risk in angel investing, many investors attempt to build a large and diversified portfolio of investments. This means having a variety of companies (at least 20+) across a range of sectors. By having exposure to many deals, angel investors increase their chances of being part of a 100x+ investment.
Building a diversified portfolio also means always being on the lookout for the next great deal. Good angel investors are continuously working their network, engaging online, meeting with founders, and attending events where they can get exposure to deal flow (visibility into new startup fundraising rounds).
Support your portfolio companies
Getting involved in your portfolio companies post-investment provides a feedback loop to determine if you made a good investment decision (which can then inform your diligence process going forward). Serving your portfolio companies well can also help you get exposure to new deals.
Reputations in angel investing are made by being a ‘value-add’ investor. This means providing your startups with good counsel, helping them navigate headwinds, introducing them to potential employees, customers, investors, and other service providers, and not being a nuisance.
This is also where specialization comes in handy. As an angel investor, it helps to lean into your core competencies and market them as your ‘value-add’ to founders. For example, if you have a background in PR / comms, offering to support portfolio companies with a media strategy is a great way to differentiate yourself from other would-be investors.
Remember that founders run in tight circles. If you serve one founder well, chances are they will refer you to their friends.
Be patient
Early-stage investors typically wait anywhere from 5-10 years before they see returns from their startup investments (assuming they see any returns at all). It’s important to have patience as an angel investor and stomach the early losses.
Remember: angel investing is about power laws. Your losing investments don’t matter as long as you have at least one excellent returner—and you typically won’t know if you hit on a great company for several years. In the meantime, the best thing you can do is continue to find ways to support your portfolio companies to improve the chances that one ends up making it big.
Become an angel investor via Angel Squad
For those looking for access to deal flow and the institutional knowledge to improve their investing skills, there’s Angel Squad.
Angel Squad is a program that teaches members how to angel invest and provides investment access to top-performing startups in Hustle Fund’s portfolio for as little as $1,000 per deal. Members are invited to hear live pitches from Hustle Fund portfolio companies, attend virtual and IRL networking events with Hustle Fund’s 1.5k+ members, and receive guidance and training from Hustle Fund managing partners, Eric Bahn and The Pitch’s own Elizabeth Yin. Learn more >>>
Want to go even deeper on angel investing and the Squad? Get Hustle Fund’s FREE Angel Investing Starter kit here >>>
FAQs
How much money do you need to become an angel investor?
To become an angel investor, you need enough money to meet the accredited investor requirements:
- Individual or joint net worth in excess of $1M (not including the value of a primary residence);
- Individual income in excess of $200k or joint income in excess of $300k for the two most recent years, with a reasonable expectation of reaching this level in the current year;
You can also angel invest without meeting these net worth requirements if you hold a Series 7, 62, or 65 license.
Do angel investors get paid back?
Angel investors get paid back when one of the companies they invest in experiences a liquidity event. The most common types of liquidity events are an IPO or acquisition by another company. Angel investors may also be able to sell their equity stake to another investor without the startup itself going under a change of control.
Note, liquidity events are exceedingly rare. Angel investors should be prepared to never be paid back on a majority of their investments.
Is angel investing tax-free?
Angel investing is not tax-free. Realized returns from angel investing are typically taxed at the long-term capital gains tax rate (assuming the asset has been held at least 3 years), which tops out at 20%. You can offset those capital gains by writing off capital losses from angel investing.
Note that many angel investors also save on capital gains by utilizing the qualified small business stock (QSBS) exemption, which allows U.S. investors to exclude or defer federal capital gains taxes upon sale of the stock.
