What is an Angel Investor?

An angel investor is a person who invests in highly risky companies, typically before those companies have any revenue or profits. Usually these companies are start-ups and/or small businesses that typically have little or no access to capital markets.

How Does an Angel Investor Work?

For example, let's say that John Doe has an idea for a way to power widgets with small, flexible solar panels rather than electricity. He needs to build a prototype and form a business in order to capitalize on the idea and begin selling the product.

John finds Ralph Jones, an angel investor. Ralph is a wealthy friend of a friend who believes in John's idea and wants to see it succeed. Ralph is comfortable with the risk that John's product may not work or that John could turn out to be a terrible businessperson. He invests $100,000 and receives 40% of the company. John uses the money to build the prototype and begin the operation. Ralph provides valuable business advice and encouragement.

Why Does an Angel Investor Matter?

Angel investors are the grass-roots foundation of commerce. They are not exactly the same as venture capitalists, which also play an important role in the formation of businesses and commerce in the world. Most angel investors are private individuals; most venture capital comes from partnerships that pool funds from wealthy individuals, investment banks, endowments, pension funds, insurance companies, various financial institutions and even other corporations.

Fund-raising for venture capital is typically done by circulating a prospectus to potential investors who then agree to commit money to the fund. Fund-raising with angel investors is typically done more casually, using networking and more verbal conversation.

One of the most common and controversial characteristics of working with angel investors is that they may take active management roles and board seats in the companies in which they invest. This often means that entrepreneurs give up some control over their businesses. However, angel investors also can provide crucial managerial or technical expertise, particularly in areas where the entrepreneur is less confident. This is especially the case when the venture capitalist specializes in the angel investor's industry or niche. Nonetheless, angel investors must be willing to take significant long-term risks for what can be very high returns.