What's an Angel Investor?

If you're a cash-strapped entrepreneur looking for an infusion of capital, you may be curious about angel investors.

By Colleen DeBasie Small business editor, The Wall Street Journal

If you're a cash-strapped entrepreneur looking for an infusion of capital, you may be curious about angel investors. Very few start-ups will receive an investment from an angel—in 2007, fewer than sixty thousand companies received angel funding, a relatively small figure considering more than ten times that many businesses are started each year. But for the right small business, this type of capital can fill the gap between that money you've gotten from friends and family and the venture capital that you hope to secure down the road.

So who is an angel exactly? An angel is a wealthy individual willing to invest in a company at its earlier stages in exchange for an ownership stake, often in the form of preferred stock or convertible debt. Angels are considered one of the oldest sources of capital for start-up entrepreneurs; the term itself, by most accounts, comes from the affluent patrons who used to finance Broadway plays in the early twentieth century. In 2007, angels invested $26 billion in 57,120 ventures, which breaks down to about $450,000 a deal, according to the Center for Venture Research at the University of New Hampshire in Durham. That makes angels a potentially powerful resource for newbie entrepreneurs with promising young companies.

But little is known or understood about the angel market, largely because it consists of individuals who make investments quietly. That is slowly changing, thanks in part to two organizations, the Angel Capital Association in Vienna, Virginia, which was founded in 2004, and its affiliate, the Angel Capital Education Foundation, which bring together angel groups to share best practices and provide basic information to entrepreneurs.

Whether you decide to seek an angel investment depends on your personal management style and the long-term plans for your company. Unlike a bank loan or other types of debt financing, equity capital (whether it's an angel investment or venture capital) gives someone else an ownership interest in your company. Many angels are successful entrepreneurs who have cashed out and now want to help others just starting out. While their expertise may be welcome, you need to ask yourself—especially if you're used to being in control—whether you want someone looking over your shoulder and making decisions for your company.

Keep in mind that an angel makes an investment in a high risk opportunity (such as your fledging company) only when a return is expected. Angels typically look for "scalable" businesses that have the potential for great growth and a clear path toward profitability. In recent memory, angels (much like venture capitalists) have been attracted to hot start-ups in fields such as technology or life sciences, although increasingly angels are branching out into other sectors and in niche, mission-based areas.

If your business—say, a corner deli or gift shop—has no great plans to expand or enter new markets, an angel investor simply won't be interested. Because angels hope to make money by taking equity—usually preferred stock—in your company and realizing a large gain when the company is sold or goes public, they generally don't invest in "lifestyle" companies—that is, small consulting firms, local restaurants, retail shops or any businesses with limited earnings potential.