Why Rich People Become Angels

Angel investors invest their own money when participating in startup fundraising rounds, where the typical amount raised ranges from hundreds of thousands to millions of dollars. The investments are usually in exchange for equity in the company. Since angel investors are very often individuals that have been executives at large corporations, they bring value to the table by providing advice and introductions to entrepreneurs, in addition to the funds.

Most angel investors are wealthy individuals who are looking for a higher rate of return than can be found in the traditional investment routes. As you may know, companies in the “startup” phase are at a very risky stage in their life and hence the risk is quite high. Moreover, most companies fail to get to a significant size, which is why angels have to diversify their investments.

You can assume that out of 10 companies that an angel investor takes a stake in, 5 would go off the cliff (return = 0), 3 would grow a bit and then stagnate (return = 2-3x) and 2 would give returns that would compensate for all the other investments (return = 5x+). All of these numbers are just simple examples, returns would vary for investors according to their acumen and industry, among other factors.

In the most well-known investment vehicle, stocks, you have to wait for more than 10 years usually to get more than 10-20x on your money. With startup funding, when you are successful your money would get 10x’d relatively very quickly, since you try to get in at the very bottom stage.

Also, startup funding can be free from the regular vagaries of the economy, the stock market, the government, the central banks, etc. that stocks in the market have to encounter. Since businesses have to run at all times, a credit crunch has little effect on them if they are not over-leveraged (have too much debt). And if startups go for funding with angel investors, that risk is mitigated to a point since that guy does not need regular payments, maybe only a board seat and a stake for him to be able to sell or use later.

You might have heard about Venture Capitalists too. The difference between VCs and angel investors is that Venture Capitalists deploy cash pooled from many investors for their investments while angels are using their own money generally, not going through a fund/fund manager per see.

You can understand why rich individuals would go to such a risky route with their money. They don’t have to worry about malpractice since they can check things first-hand. They know the 80-20 rule would play out and one or two of their portfolio companies would make them whole plus more in terms of money. They have greater access to deal flow as their network expands and gets better. And as I already said, good startups would not get affected too much when the economy or stock market is going through tough times.

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