Explainer: What are Angel Investors?

Explainer: What are Angel Investors?

So-called angel investment arrangements have long been existing even prior to the popular use of the terminology. For example, the term “angel” was ascribed to individuals who provided financial support in staging Broadway shows.

William Wetzel borrowed the term in 1978 while completing his research about sources of seed capital. He used the term “angels” to describe individuals who finance the early stages of business ventures. It was a fitting label because entrepreneurs felt as if money came down from heaven with the arrival of these seeming informal and non-venture capital investors.

Throughout the history of angel investment arrangements, angel investors have made notable deals that paved the way for the emergence of some of the largest and most valuable companies in the United States. For example, Apple Inc. received funding and expert assistance from business angel Mike Markkula who poured in an investment amounting to USD 91,000 and exited with a value amounting to USD 154 million. The electronic commerce giant Amazon also received funding from business angel Thomas Alberg who invested an amount of USD 500,000 and exited with a value amounting to USD 26 million.

Understanding the Profile of Angel Investors: Who Are Business Angels? Where Do They Come From?

Definition and Background

In formally defining angel investors, Wetzel described them as individuals or groups who play a key role in providing seed capital for entrepreneurs and even inventors for startup and small technology-based companies operating within a high-risk capital market. They share some similarities with venture capitalists.

Separate studies from R. Aernoudt and H. Landstorm further shed light on the characteristics of this unique breed of investors. Accordingly, most, if not all, of these individuals have strong business backgrounds, including demonstrated entrepreneurial and managerial experience.

They fall within the age range of 35 to 65—considered relatively young as they intend to see how their investments would make a difference, although they are merely interested in minority stake and they are making less than 25 percent of the amount of assets allotted for informal investment.

Source of Funding and Motivation

In addition, most of these individuals sit on immense wealth obtained from selling their companies or shares on highly advantageous terms. Some of them are executives of large companies, while others are part-owners of multiple business ventures.

Angel investors are essentially individuals or groups of individuals who seek to make something out of their unused wealth. They are also keen on guiding aspiring entrepreneurs by sharing their experience and providing expertise through whatever means.

The motivations of these investors can vary. Some are motivated by wealth creation, while others are looking for something to do in their free time. Some simply want to help aspiring business owners who possess the necessary competencies and breakthrough business ideas.

Structure of Business Angels and Regulation of Angel Investors: What Does a Business Angel Do?

Structure and Functions

Angel investors operate either as independent individuals or as a group. In his paper, Yilmaz Bayer mentioned that individual angel investors usually form a group to have more discretion in evaluating business ventures seeking financial support. These groups are relatively new.

In the United States, organized angel investors first emerged during the 1990s while individual angels have been existing way back. Nonetheless, the growing number of angel groups and networks promotes organization and formalization. Hence, despite being an alternative and informal source of investments, angel investors still operate systematically.

According to Bayer, angels follow a typical step-by-step cycle that includes the following: (1) awareness of investment opportunity; (2) initial assessment and identification of whether the proposed venture fits in their investment portfolio or area of expertise; (3) meeting with the entrepreneurs; (4) negotiations; (5) investments and provision of hands-on support or managerial advise; and (6) exit from the business through initial public offering or selling of shares.

Government Regulation

Regulations of investments from business angels fall within various legal domains. However, in her working paper presented to the U.S. Government Small Business Administration, Dr. S. Shane explained that business angels do not have a fiduciary relationship with other investors. Thus they are usually not regulated by the federal government.

The absence of a fiduciary relationship allows these investors to use an array of financial instruments to include pure debt and pure equity. However, there are business angels who are accredited investors. Take note that the federal securities laws subject these accredited investors under the watchful eye of the Securities and Exchange Commission.

Of course, because they cater to different forms of businesses such as sole proprietorship, partnership, including general partnership and limited liability partnership, limited liability company, and corporation, they may be subjected to specific regulations and standards under a particular business form.

Economic Importance of Angel Investors: What Are the Economic Impacts of Angel Investments?

The economic impacts of angel investors are worth discussing. According to the study of Paul A. Gompers, these investors have paved the way for the emergence of small businesses and upstarts during the 1980s. It is important to note that before this decade, large and established American companies were starting to reduce a considerable portion of their workforce until unemployment numbers grew to millions by the end of the 1970s.

However, by the 1980s, the role played by these business angels in financing small businesses and upstarts reignited the employment rate. By the end of this decade and with the arrival of the 1990s, small businesses and upstarts have become the main driver of job creation. These businesses were usually more innovative than large and established companies.

An empirical research conducted by D. Polis revealed that angel investors not only help individuals pursue their entrepreneurial visions by providing the necessary funding needed to meet capital requirements but also add value to emerging businesses. Specifically, these investors add value by providing their expertise, competencies, and experiences needed to manage and direct the growth of startup businesses.

Finding a suitable angel investor can be a source of competitive advantage. Furthermore, when integrated as part of a market entry strategy, a competent business angel can help a startup business expand its network and lower barriers to entry.

FURTHER READINGS AND REFERENCES

  • Aernoudt, R. 1999. “Business Angels: Should They Fly On Their Own Wings?” Venture Capital. 1(2): 187-195. DOI: 1080/136910699295965
  • Bayar, Yilmaz. 2013. “Angel Financing in Early Stages of Company Development.” International Journal of Economics and Finance Studies. 5(1). ISSN: 1309-8055
  • Gompers, P. A. 1994, “The Rise and Fall of Venture Capital.” Business and Economic History. 23(2). ISSN: 0849-6825. Available via PDF
  • Landström, H. 1998. “Informal Investors as Entrepreneurs. Technovation. 18(5): 321-333. DOI: 1016/s0166-4972(98)00001-7
  • Politis, D. 2008. “Business Angels and Value Added: What Do We Know and Where Do We Go?” Venture Capital. 10(2): 127-147. DOI: 1080/13691060801946147
  • Shane, S. 2008. The Importance of Angel Investing in Financing the Growth of Entrepreneurial Ventures. Working Paper. U.S. Small Business Administration, Office of Advocacy. Available via PDF