It's hard to beat the excitement that comes from angel investing.
You might have heard about big-name angel investors like Jeff Clavier, the founder of Uncork Capital. He's made successful early-stage investments in Fitbit Inc. (NYSE: FIT), Eventbrite Inc. (NYSE: EB), and Mint.com, among others. His golden touch has made him a regular on the Forbes Midas List of top tech dealmakers.
Or there's Chris Sacca, the former Google employee and founder of Lowercase Capital who invested early in Twitter Inc. (NYSE: TWTR), Instagram, and Kickstarter. He retired from speculative investing in 2017, but not before building his net worth to more than a billion dollars.
It's not surprising that Amazon.com Inc. (NASDAQ: AMZN) CEO Jeff Bezos has also gotten into the angel investing game. His venture capital firm, Bezos Expeditions, has made early investments in the likes of Uber Technologies Inc. (NYSE: UBER), Airbnb, Workday Inc. (NASDAQ: WDAY), and Nextdoor.
Bezos himself, of course, benefited from 22 "angels" who supported Amazon when it was a fledgling online bookseller in the mid-1990s.
Those investments, many by Bezos' family and friends, came in at only $50,000 apiece for 1% of the company. Those shares are now worth more than $8.5 billion. That's a 17-million-percent gain in 25 years!
But the truth is, you don't even need $50,000 to become an angel investor yourself.
In fact, we'll show you how you get can a piece of the next Amazon for about the price of one of its Echo Dot smart speakers.
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That's right. If you've got $50, you too can be an angel investor. And by the time you get to the end of this article, you'll be ready to start picking companies and dive into this exciting and hugely profitable segment of the investing world.
But first, let's take a closer look at exactly what goes into angel investing…
What Is Angel Investing?
The term "angel investor" was originally supplied to wealthy individuals who would single-handedly keep a struggling theater alive. Today angel investors provide seed capital to startups before they've gone public. In return, the angel investor is given a stake in that company.
It's similar to buying shares of a stock, only it's not on a public exchange like the New York Stock Exchange or the Nasdaq. And the terms of ownership might be slightly different.
Some angel investment agreements involve buying preferred stock (which comes with greater privileges than the common stock you'd typically buy on a stock exchange). Other angel investing deals involve convertible debt or bonds that the investor can choose to convert into common stock down the road.
Angel investing is similar to venture capitalism, another term you've probably heard. But there are some key differences…
Angels typically invest in companies at earlier stages than venture capitalists do. Businesses will typically be valued at less than $5 million when angel investors step in.
Angels often fill the gap after companies have gotten their initial investment from family, friends, and acquaintances and before venture capital firms enter the process. The business idea has been tested and is generating revenue, but the enterprise has not reached a large scale.
And while venture capitalists are usually part of a firm with multiple decision-makers involved, angel investors often work solo. What they choose to invest in is at their own discretion, subject to no one else's approval.
That's also what makes angel investing fun. Because angels can invest in what personally interests them. And since they are an early backer, they often interact with the business and can offer input on which direction to go.
That's a lot more involved – and some would say better – than buying shares of a public company and only getting a handful of votes out of millions.
Of course, there is a cost to that access. You might not have a lot of say as a shareholder in Johnson & Johnson (NYSE: JNJ), but there's very little risk of the company going belly-up tomorrow.
The companies you come across as an angel investor are going to have a much different risk-reward profile than Johnson & Johnson. So if you want to be successful, you'll need to approach these investments with an entirely different strategy than you would use for traditional stock investing.
Rethinking the Math as an Angel Investor
Angel investing requires more risks than traditional investing, but the rewards are astronomically higher. So it should take up a relatively small portion of your portfolio. We recommend the 50-40-10 model, which allocates 10% of your portfolio to speculative investments, though you might choose a different model depending on your investing priorities.
Whatever model you choose, most of your portfolio will probably be allocated to defensive and growth positions. That means you're aiming for consistent, reliable returns from all those investments, with very few losers in the bunch.
With angel investing, the math is different. Instead of aiming for every investment to return 10% or 20% year after year, angel investors only need one or two of their investments to return 1,000% (or more) to make it worth it.
That's why it's best to invest small amounts of money – as little as $50 each – in a wide range of startups rather than large amounts into just a few.
This is a difficult mindset for traditional investors to adopt. You can invest in 20 companies, watch 19 of them fail, and still be incredibly successful. Because that one winner could be the next Amazon that turns your $50 into millions.
So as you start investing in private companies and learn the many technical details involved in those agreements, always remember this: Finding the right company is everything.
Those early investors in Amazon probably don't care whether their investment was classified as convertible debt or preferred stock. Because we're not talking about a 5% or 10% return here, where every nuance of the deal affects your bottom line.
We're talking about returns of 1,000%, 10,000%, or maybe even 10,000,000%. We're talking about the kinds of returns where you can tell people you were an early investor in Company X, and they ask you how many boats you own.
Then you won't care much about the technical details of the deal.
And you won't care about the 10 or 20 other companies you invested in that didn't take off.
That being said, there are some details you will want to pay very close attention to before you put even as little as $50 into any company.
And the first is one that, when you first hear it, might scare you: stock dilution.
The Basics of Stock Dilution in Angel Investing
If you've seen the movie "The Social Network" about the founding of Facebook Inc. (NASDAQ: FB), you probably remember the scene in which the company's co-founder Eduardo Saverin finds out that his shares have been "diluted."
A $500,000 investment from billionaire Peter Thiel (an angel investor) had raised the value of the young startup significantly. But Saverin's shares didn't increase in value. His ownership stake in Facebook had instantly dropped from 34% to just 0.03%, with Thiel and the other stakeholders now owning the rest.
The real story is more complicated than that. But dilution is a real thing in the angel investing world. It's also not as scary as The Social Network made it out to be.
(By the way, the real Eduardo Saverin is indeed a billionaire today, thanks to his early investment in Facebook.)
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Say an investor puts $250,000 into a $500,000 company. In many cases, the result will be that this investor now owns one-third of a $750,000 company. The company is more valuable, but the existing shareholders didn't see the value of their investments rise, and their ownership percentage has decreased.
That doesn't sound fun. But it may actually be to your advantage. Dilution in this case doesn't reduce the dollar value of your shares, only the ownership percentage. It's better to own 1% of a company ready to break out than 2% of a company ready to collapse. And surges of capital like this are often a strong indication that you've picked a winner.
The key is to be certain up front about what your rights are regarding dilution. If your shares can only be diluted by the same percentage as the company's founders and everybody else, you probably don't need to worry. If it's possible for other shareholders to maintain their ownership percentage while diluting your shares into oblivion, on the other hand, that's a deal you want to stay far, far away from.
In addition to dilution, there's one more thing that's critical for an angel investor to consider before getting into an investment…
When to get out.
Setting Your Exit Point as an Angel Investor
As we pointed out before, those early $50,000 investments in Amazon could now be worth $8.5 billion. But there's a problem with that: You haven't made any money until the funds are in your bank account.
Any rise in the value of your shares is unrealized gain until you sell those shares. And you can't spend an unrealized gain.
You want to bank at least some of the gains you make as an angel investor as you go. And that means you need an exit point, or a liquidity event, at which point you can trade your shares in the company for cash after you've made a sizeable return.
In a lot of cases, that exit point will be the IPO. This, actually, is where angel investing becomes really fun. Because you've probably been warned as an investor to avoid IPOs. That's what we typically recommend at Money Morning. You see, IPOs are rigged against retail investors like you and me, who end up paying a premium for a good but overvalued company.
As an angel investor, though, you are one of the beneficiaries of that system. Which is why a company's IPO is a great time to bank your gains.
If you really believe in the company's long-term potential, you might decide to sell half your shares and hold onto the other half to keep enjoying the company's rise. Or you can sell at the IPO and then buy common shares on the market later when the price is favorable.
Another possible exit point is acquisition.
If you pay attention to financial news, you'll see story after story of big conglomerates buying up young companies for billions of dollars. It may be because the conglomerate is actively expanding its portfolio, or it may be to eliminate competition. Either way, it's a potential big payday for you.
When you're choosing which startups to invest in, aim for companies that are likely to have an exit point within the next five years. That way, you're not waiting too long to bank your potential gains. And once you've been doing angel investing for a few years, you should have exit points occurring on a regular basis.
With the basics of angel investing out of the way, there's only one thing left to do, and it's the most important step of all: pick the right companies to invest in.
Taking the Plunge into Angel Investing
We said before that there is no substitute for picking the right startups. All the technical know-how, all the financial wizardry, all the negotiating power in the world means nothing to an angel investor if they pick a bunch of duds.
We also said that an angel investor doesn't have to hit a home run every time. If even one company out of 10, or maybe even one out of 20, really takes off, that could easily be enough to make it fantastically profitable.
But there's a world of difference between getting one out of 20 and getting zero out of 20. It's the difference between a successful angel investor and a complete failure.
So picking a portfolio to ensure that you get that one startup – or two, or three – that takes off is absolutely critical.
And if you've never invested in early-stage companies before, the prospect of finding the right ones might seem hopelessly daunting.
Thankfully, you don't have to do it alone.
We've got two of the world's most successful angel investors to get you on your way to investing in winning startups and collecting the huge profits that come with it.
As long as you've got $50, you can join the exciting, exclusive world of angel investing right now…
Anyone Can Become an Angel Investor with as Little as $50
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This article is supplied courtesy of Money Morning.