Clear as mud
Individuals can get confused or frustrated trying to understand where to begin their angel investing journey. This is no fault of their own, but rather the result of overlapping challenges:
- Internet searches show only a tiny fragment of potential early-stage investment opportunities. This is because angel investments are private equity (not publicly traded), so to stay within Security and Exchange Commission (SEC) regulations, startups and investment funds cannot normally advertise openly.
- Traditional financial advisors may have an incentive not to discuss angel investing with clients, because they are generally paid based on how much wealth they manage on their platform (assets under management). This means that diverting a portion of your investment portfolio into private angel investments could cut into their pay.
- Culturally, as Minnesotans, talking about money and wealth can be taboo, which can hinder the exchange of information around angel investment opportunities.
Angel investing is not for everyone. Among other things, a person should consider the illiquidity, risk profile, and the longer-term nature of early-stage startup investing prior to jumping in. For those who decide to start angel investing, there are four main ways to do so: as a Limited Partner in an early-stage fund, joining an angel network, investing with a syndicate, or as a solo angel.
Limited partner within a fund
As a Limited Partner (LP) in a venture fund, you are pooling your money with other angels and deferring investment decisions to a General Partner(s). This eliminates the need to directly interface with founders or startups, making it the most passive way to become involved in angel investing. This is a great option for people who quickly want diversification in a variety of startups but have limited time to commit to angel investing, or do not want to be deep in the weeds. Quality funds will also have systems in place to help the companies in their portfolio throughout their growth.
The downside is the General Partner, on behalf of the fund, may invest in startups that you don’t like or believe in. It is also possible you may feel disconnected from the startups that you have invested in—the personal connection with founders is a highlight for many angels. Moreover, the biggest potential drawback as an LP, is the management fees and carried interest (percentage of returns kept, typically 20%), which will inevitably cut into your potential gains. The minimum investment amount for LPs in early-stage funds is typically $100,000-$500,000. Sometimes this will be separated into installments over a defined timeline (perhaps 2 or 3 years), but it can still be prohibitive.
When evaluating a fund, you should scrutinize the General Partners’ experience, including their access to deal flow and ability to pick quality startups. It is important to understand the fund’s investment thesis to ensure it is aligned with your goals and interests. Review the management fees, carried interest, and minimum investment amount. If you are looking at a local Minnesota-based fund, ask if they are utilizing the Minnesota Angel Tax Credit Program, which can help hedge your financial risk. It is important to remember that funds are limited by the number of LPs and/or total capital they can raise, so it may take time to find a fund that aligns with your investment thesis, has LP slots available, and has a minimum investment amount that is within your budget.
Angel networks
Angel networks come in a variety of shapes and sizes. Their general purpose is to pool resources and share the responsibilities of sourcing quality deals, conducting due diligence, and negotiating deal terms. The main difference from a fund is that each angel has the autonomy to invest (or, at minimum, vote), giving angels in network more control over their portfolio. For many people, this pathway also provides a deeper connection to the startups that they are investing in.
As an investor listed separately on the startup’s capitalization table (often referred to as “cap table”), you should expect direct updates and reports from the founder. The investment minimum per check is typically around $25,000. However, the specific amount is based on the founder’s discretion.
Some angel groups utilize Special Purpose Vehicles (often called an “SPV”) on a per-deal basis. You can think of SPVs as mini funds used to pool investments on a particular deal. This allows investors to participate at a lower minimum, so long as the SPV meets the minimum set by the founder. There are fees involved with setting up an SPV. Those fees are often passed on to the individuals investing through the SPV.
Depending on the angel group, you may be required to participate in the deal sourcing, screening, and due diligence. As a direct angel, you will be signing separate investment documents for each investment you make. For Minnesota-based companies, you’ll need to make sure the investment documents are compatible with the Minnesota Angel Tax Credit Program. You will be responsible for handling the paperwork with the state government on your own behalf.
Like your evaluation of a fund, you should consider the angel group’s access to deal flow and the time commitment expected of you as a member of the community. Angel groups generally charge a membership fee regardless of the number of investments you make, and some may also charge carried interest on the gains. It is important to look into the specific terms. You should also ask if there are any annual investment minimum requirements of the group.
Syndicate groups
Syndicate groups function similarly to an angel network, sharing responsibilities and resources. They are often formed by a small group of colleagues, friends, or group with a shared interest (e.g. alumni of a college or university). The main differentiating factor is that syndicates are not open for outside members to join. Rather, they operate as private investment groups that work together to angel invest as a collective.
The syndicate will form an entity, which will operate under its own established bylaws and serves as the investor. This leaves the syndicate, and its members, responsible for all its own tax, legal, and operational duties. However, those costs get split among the members. When considering setting up a syndicate it is important to have honest and frank conversations with the group to establish expectations around role and responsibilities, time commitments, capital contributions, and overall alignment of investment thesis. You will want to ensure everyone is aligned and standard operating procedures are in place to ensure a smooth working relationship over a longer time horizon (typically 7-10 years).
Solo angel
Of the four options, investing as a solo angel is the most time-consuming and challenging way to get into angel investing. These are individuals who operate on their own to make angel investments. The biggest advantages are the absence of management fees, membership requirements, and carried interest taken from your gains.
You should, however, anticipate a significant amount of time going into your own personal deal sourcing, due diligence, and direct negotiation of deal terms. Most solo angels treat angel investing like their job, putting an immense amount of time and attention into it. Solo angels are responsible for the costs, including legal, accounting, tax, and any other services needed to facilitate the paperwork and ongoing management of each investment. Like angel syndicates, you will be responsible for filing the necessary information to utilize the Minnesota Angel Tax Credit Program. An additional challenge with solo investing is that it requires more capital to build out your angel portfolio. This is because you, as an individual, will need to meet the minimum investment amount on each deal (often around $25,000 for pre-seed or $50,000 for seed-stage deals)
Conclusion
One size does not fit all when it comes to angel investing. Your personal situation will dictate which path is more suitable for you, and it may change with time. Many angels choose to participate in more than one way simultaneously. In addition to the angel networks listed on Angel Basecamp, you can check out the various Minnesota funds on Launch Minnesota’s website (mn.gov/launchmn). Keep in mind when looking at the list that, depending on the life cycle of the fund, it could be closed to new investors or fully deployed.
