Are you curious about investing in high-growth businesses in the start-up phase? Do you want to take the risks and enjoy the rewards of having equity stakes in small businesses? Do you relish the prospect of scrutinising companies with disruptive ideas and innovative strategies? If so, it sounds like you’re looking to learn how to become an angel investor in the UK.
What is an angel investor?
An angel investor provides finance to small businesses in exchange for a minority equity stake. Angel investors tend to invest at a very early stage in the business’s development.
Angel investors can be a lifetime for start-ups with high risk or unproven business models, who would otherwise find it difficult or impossible to obtain a bank loan.
In return for the high risk, angel investors can buy-in at relatively low valuations. This provides considerable upside on the investment in the unlikely scenario that the business is highly successful.
The angel investor mindset
Start-up businesses have a high rate of failure. It follows that angel investing requires a very different mindset from investing in index funds or investing in property.
Some angel investors prefer to think of their angel investments as an ‘expenditure’ rather than an investment. They expect, and are not dissuaded by some of their investments failing, because this is part of the process.
In their view, they are spending money across a diversified group of start-ups to access opportunities for high growth. They do so with the hope that one or more of the investments will perform spectacularly well. A single investment in a group of 10 shareholdings could produce a return that compensates the investor for any losses and provides an overall profit to the investor.
Where an angel investor provides seed funding to a start-up which eventually lists through an Initial Public Offering (IPO), returns of 10,000% – 100,000% on that initial seed investment are not unheard of.
Successful angel investors who hit it lucky by choosing the right business can achieve compounded returns of 30% p.a across their angel investment portfolio. On the other hand, some angel investors don’t see a positive return.
What does an angel investor look like?
Angel investors usually meet the criteria to self-identify as a sophisticated investor. Although not all sophisticated investors choose to become an angel investor.
As a quick reminder, the FCA definition of sophisticated investor includes people who can tick one of the following boxes:
- Existing member of a club of angel investors / business angel syndicate
- Has prior experience of investing in unlisted companies
- Professional background in private equity / venture capital / provision of finance
- Company director of a company with turnover exceeding £1m
Angel investors tend to be in their 40s and up. At this stage in their career, they have a wealth of business experience which they can bring to the table in their capacity as an adviser to the business. An angel investor is as much a business adviser & mentor to their investments, as they are a source of finance.
What do angel investors actually do?
Angel investors take an active interest in the businesses they invest in. Some angel investors spend hundreds of hours per year supporting their investments, helping them navigate issues and even open doors for them within their marketplace.
If you’ve watched an episode of The BBCs’ Dragons’ Den, you’ll often hear the Dragons explain what they can offer the entrepreneur making the pitch. This ranges from:
- Taking an active management role
- Providing access to social connections in their industry
- Offering strategic advice on product & marketing
- Helping to coach the management team on financial literacy
Read more: The best financial literacy books
How to become an angel investor
To become an angel investor, you will need to start with a substantial amount of capital. It is generally recommended that angel investors allocate no more than 10% of their overall investment portfolio to alternative investments such as unlisted equity.
Multiple investments are needed to diversify and each opportunity will have a relatively high minimum investment. Putting all of this together:
10 investments @ £40,000 each = £400,000 angel investments / 10% = £4m total investment portfolio required.
This illustration shows why angel investors are usually high net worth individuals. It’s only at that scale that an investor can create a diversified portfolio whilst capping their overall asset allocation to this risky asset class.
Angel investors often begin their adventure through a social or family connection. A sister-in-law has a great business idea, and asks the angel to invest in their new business in return for an equity stake.
But to adequately diversify, an angel investor will need to actively network to source new investment opportunities. For every deal which is closed, an angel investor could have screened over 100 opportunities.
Due diligence is critical because many business ideas simply don’t contain enough potential upside to compensate the investor for the risk. Read more: The best due diligence books
Entrepreneur awards and conferences can be excellent places to meet high-performing individuals seeking capital.
Angel investor clubs & syndicates
Angel investors often club together to share ideas, and jointly invest in a start-up. These informal groups are known as angel investor clubs, business angel syndicates or similar.
The legal & administration costs of conducting a funding round can be expensive. However, by investing as a group, these expenses can be shared, which makes it more economical for angels to invest smaller sums. This is how to become an angel investor with a smaller sum than the figure discussed above.
The largest angel investment clubs allow members of the public to participate with less than £1,000. However, bear in mind that when investing £1,000, the angel cannot expect to have the same level of engagement with the business owners as an angel who invests £100,000. It becomes a more passive investment.
What is the difference between an angel investor and a venture capitalist?
You might be wondering if the answer to ‘how to become an angel investor’ is the same as ‘how to become a venture capitalist’. What is the difference between these two types of investors?
The main difference is that an angel investor acts as a private individual, investing in their own name. Even when investing as part of a syndicate, the syndicate merely helps to organise and co-ordinate what is actually a series of individual deals.
In contrast, venture capital firms are collective investment vehicles which invest cash across a portfolio of unlisted investments.
These funds, known as venture capital trusts (definition) in the UK, are semi-regulated organisations with employees, partners, and a body of investors who have contributed to the fund. You could see them as ‘corporate’ angel investors. The best venture capital trusts spread investor money across as many as 100 individual investments.
An investment in a venture capital fund is a totally passive investment, as the employees and partners of the VC firm will work tirelessly to monitor the investment, help to engineer exit opportunities and in many cases provide management expertise to the investee.
Angel investing is the ‘DIY’ variation of this process. Business angels must source their own due diligence services and legal advisors, and pro-actively engage with the investee to nudge and advise them towards the best outcome.
Read more: The best venture capital books
How to become an angel investor: a summary
In summary, here is how to become an angel investor. This is not financial advice, please seek independent financial advice and read-widely before engaging in high risk investments such as angel investing.
- Begin with a significant amount of capital and experience of investing
- Network extensively to discover and screen potential investment opportunities
- Consider affiliating yourself with an angel investor club or syndicate
- Invest across multiple start-up businesses to diversify
- Constrain your unlisted investments to 10% of your overall investment portfolio
- Actively engage with the businesses and provide support to help them grow
- Expect several of your investments to fail completely
- Seek exit opportunities at a later stage (e.g. 5 – 10 years) to realise a profit on your top picks