When it comes to investing your money into businesses, there are 3 main ways you can do that:
- The first is to invest in starting your own business
- The second is to invest in publicly listed companies (i.e. Stocks)
- And the third is to invest in start-ups (i.e. Angel Investing)
The first two are what people are most familiar with. Angel investing, on the other hand, is less well-known, less accessible, and probably the least understood.
In this blog post, we’re going to take a look at what angel investing is and how it compares to investing in stocks across a few different factors:
- The potential rewards
- The risks involved
- The research / due diligence process
- The barriers to entry
- The work involved
What Is Angel Investing?
Angel investors are people who invest their own money in start-up businesses in exchange for a share of the company’s ownership.
The name “angel” comes from the fact that these investors are often the only source of funding for these businesses, and thus they are seen as a godsend or angels.
Angel investing is a high-risk, high-reward type of investment. Because start-ups don’t have a track record, it’s hard to predict which ones will succeed and which ones will fail.
As such, angel investors often lose their entire investment in a start-up that fails. However, if the start-up succeeds, the rewards can be huge.
For example, early investors in companies like Facebook, Snapchat and Twitter made returns of over 10,000%!
How Does Angel Investing Work?
The process of angel investing usually goes something like this:
- The entrepreneur comes up with an idea for a business and creates a business plan.
- The entrepreneur presents the business plan to potential investors (i.e. angel investors).
- If the investor likes the business plan, they will invest money into the company in exchange for equity (i.e. ownership).
- The entrepreneur uses the money to start and grow the business.
- If the business is successful, the investor can make a lot of money when they sell their equity stake through mediums such as an Initial Public Offering (IPO) (which is when a company becomes publicly listed) or an acquisition by a larger company. If the business fails, the investor will usually lose all of their money.
The Potential Rewards: Angel Investing VS Stocks
The potential rewards of angel investing can be much higher than investing in stocks. This is because, with stocks, you are buying a piece of an already established company.
Potential Returns For Stocks
The growth potential of the company is limited by the size of the overall market.
For example, even if Facebook grows at 20% per year, it will eventually reach a point where it’s no longer possible to grow at that rate (because there are only so many people in the world who can use Facebook). At that point, the stock price will plateau and investors will only make money if the company pays out dividends.
Potential Returns For Angel Investing
With angel investing, on the other hand, you are investing in a start-up that has the potential to grow exponentially. If the company is successful, you could make a return of 10,000% or more!
This is the most appealing aspect of angel investing. However, of course, the flip side is that you are also much more likely to lose your entire investment if the company fails.
The Risks Involved: Angel Investing VS Stocks
As we’ve just mentioned, the potential rewards of angel investing can be much higher than stocks. But so are the risks.
Risks Involved With Stocks
With stocks, you are buying a piece of an already established company. The company has a track record and you can research the industry to get an idea of how well the company is likely to do in the future.
Furthermore, to hedge against risk, you can make smaller bets and diversify your risks across various different stocks through effective position-sizing. You can also enter and exit your investments and trades quite easily if there’s enough trading volume, which most large publicly listed companies will have.
Risks Involved With Angel Investing
With angel investing, on the other hand, you are investing in a start-up that has no track record. It’s hard to predict which start-ups will succeed and which will fail. As such, you are much more likely to lose your entire investment if the company fails.
Even if you try to mitigate your angel investing risk by diversifying across different start-ups with position-sizing, each position typically ranges from around $1,000 to $20,000.
These positions aren’t one-off investments either. Your ownership in companies will get diluted over time as the start-up raises more and more money at different valuations (a somewhat complicated process that would require another blog post to explain), meaning you’d have to keep contributing money to the start-up just to maintain your existing ownership percentage.
Angel investments are also not something that you can just decide to exit easily either – because they’re not publicly listed, there typically isn’t a lot of opportunity for you to just sell off your portion of the company whenever you want to call it quits.
Research and Due Diligence: Angel Investing VS Stocks
Research and Due Diligence for Stocks
Investing in stocks is a relatively easy process. You can buy and sell stocks online through a brokerage account. And there is a lot of information available about individual companies and the overall stock market, especially if you’re focusing on US-listed companies.
This makes it relatively easy to do your research and due diligence before making an investment, and after you’ve made your investment.
Research and Due Diligence for Angel Investments
Angel investing is a bit more complicated.
It’s not as easy to find information about individual start-ups as they tend to be very private with their ‘secret sauce’ and intellectual property unless you’ve made some sort of commitment to invest a certain amount in their company or at least signed a Non-Disclosure Agreement (NDA) contract (i.e. an agreement not to share private information to third parties).
On top of that, it’s very difficult to assess the value of a start-up, as that is mostly determined by a combination of what the founders think it’s worth, and the level of demand by angel investors – especially at the very early stages of the company. With very little financials and no real track record to base your investment decisions on, your best bet is to invest in the founders that you believe in.
This means that it can be harder to do your research and due diligence before making an investment.
Liquidity: Angel Investing VS Stocks
Another key difference between angel investing and stock investing is the liquidity of the investment.
Liquidity for Stocks
Stocks are one of the most liquid assets in the world, which means they can be easily bought and sold on public stock exchanges with little to no fees. You can also choose to hold onto your stocks for as long or as short as you want – there’s no minimum holding period.
Liquidity for Angel Investments
Angel investments are much less liquid than stocks, which means they can’t be easily bought or sold. In most cases, you will need to find a buyer who is willing to purchase your shares from you, and this can often be difficult and time-consuming.
Another thing to keep in mind is that there is usually a minimum holding period for angel investments of around three to five years, which means you won’t be able to access your money as quickly as you could with stocks.
Barriers To Entry: Angel Investing VS Stocks
Barrier of Entry for Stocks
Investing in stocks is a relatively easy process. As long as you are of the right legal age, you can open a brokerage account and start buying and selling stocks with just a few clicks.
Barrier of Entry for Angel Investments
The barriers to entry are much higher for angel investing than they are for stocks, which means that it’s less accessible for the average person.
The first barrier of entry is you’ll need to meet the legal requirements of being what’s called a sophisticated investor (Australia) or accredited investor (United States), which has nothing to do with your ability, but rather how wealthy you are.
As an example, in Australia the requirements for being a sophisticated investor are that you must receive certification from a qualified accountant stating that:
- You either possess net assets of $2.5 million OR
- Your gross income has reached at least $250,000 per year for the last two financial years
This dramatically limits the number of people who can access angel investment opportunities.
On top of that, to source opportunities, you usually need to be connected to the startup ecosystem in some way. This could mean being part of an angel group or venture capital firm, or actively networking with start-up founders.
Work Involved: Angel Investing VS Stocks
Both angel investing and stock investing are flexible in terms of the amount of activity and work required from you as an investor.
Work Involved for Stocks
If you want to be passive as a stock investor, you can choose to invest in index funds, or opt for a buy-and-hold, long-term value investment strategy. You can also hand your money over to a fund manager, however, you will have to pay management fees, and you will have less control over where your money is being invested.
If you want to be active as a stock investor, you can easily research companies through publicly available information on sites such as Yahoo Finance as well as look at the decisions of smart fund managers on paid subscription platforms.
Unless you’re day trading (which I personally don’t advocate), the process of stock investing and swing trading doesn’t require as much time and effort as angel investing – typically taking about 30-45 minutes a day if you’ve got your systems set up.
Work Involved for Angel Investments
If you want to be passive as an angel investor, you can choose to invest in a venture capital or angel syndicate fund, which will source and manage investments on your behalf. However, the downside is that you will have less control over where your money is being invested and you will likely pay higher fees.
If you want to be active as an angel investor, you’ll need to spend a lot of time researching and due diligence on individual companies as well as the startup ecosystem as a whole. This process can easily take up a few hours a day, especially if you’ve got a particularly high-maintenance portfolio filled with early-stage companies, which require more time and attention than later-stage companies.
Active angel investing also requires you to be more hands-on than stock investing, as you may need to provide your network, as well as mentorship and advice to startup founders.
Starting Capital Required: Angel Investing VS Stocks
The amount of starting capital required to get started with angel investing or stock investing can vary depending on the size and stage of the companies you’re investing in, as well as your investment strategy.
Starting Capital Required for Stocks
If you’re planning on buying stocks, you can start with as little as $100 a month if you stick to a long-term buy-and-hold approach. However, if you want to be more active with trading shares in more established companies, I would say you’d need at least $20,000. I talk about this in more detail here.
Starting Capital Required for Angel Investing
As mentioned previously, to invest in a start-up, each position typically ranges from $1,000 to $20,000. This means if you want to position-size and diversify your investments, you will need at least ten times that amount ($10,000 – $200,000) – and that’s if you succeed with picking at least 1 winner out of 10 start-ups (about 90% of start-ups fail).
Furthermore, because of the highly speculative and risky nature of start-ups, that angel investment capital should only form a small fraction of your net worth – hence the need for legal requirements of sophisticated/accredited investors having at least $2 million in net assets.
So, Which Is Better? Stocks Or Angel Investing?
The answer to this question really depends on your individual circumstances.
- Meet the legal requirements of being a sophisticated or accredited investor
- Are only allocating a small portion of your wealth towards angel investing
- Are willing to take on more risk for the potential of higher returns and are comfortable with a more illiquid investment
- Are able to contribute more than just money to start-ups (i.e. Your network or expertise)
- Are passionate about helping business and start-ups change the future of the world
Then angel investing might be for you.
On the other hand, if you:
- Are looking for a more hands-off investment with lower risk and easier liquidity
- Don’t mind sacrificing some upside potential for downside risk-mitigation
- Want to have a more broad-based portfolio with exposure to different asset classes and industries
- Like the idea of being able to start small and take multiple positions over time
- Want to have a better idea of what you’re investing in by having access to company financials
- Like to be emotionally detached from your investments
Then investing in stocks might be more up your alley.
That isn’t to say you can’t do both if you meet the requirements for a sophisticated/accredited investor – you definitely can if both forms of investing appeal to your interest.
Just be sure to structure your portfolio in a way that reflects your risk tolerance.
The Bottom Line
Whether you choose to invest in stocks or angel investing, remember to always do your own due diligence and research before making any decisions.
And if you’re ever in doubt, there’s nothing wrong with seeking professional financial advice.