An angel investor (known as a "business angel" in Europe, or simply an "angel") is an affluent individual who provides capital for a business start-up, usually in exchange for ownership equity. Angels typically invest their own funds, unlike venture capitalists, who manage the pooled money of others in a professionally-managed fund. However, a small but increasing number of angel investors are organizing themselves into angel networks or angel groups to share research and pool their investment capital.
Angel capital fills the gap in start-up financing between the "three F"s (friends, family, and fools) of seed capital, and venture capital. While it is usually difficult to raise more than US$100,000 - US$200,000 from friends and family, most traditional venture capital funds are usually not able to consider investments under US$1 - 2 million. Thus, angel investment is a common second round of financing for high-growth start-ups, and accounts in total for almost as much money invested annually as all venture capital funds combined, but into more than ten times as many companies (US$25.6 billion vs. $26.1 billion in the US in 2006, into 51,000 companies vs. 3,522 companies, ).
Angel investments bear extremely high risk, and thus require a very high return on investment. Because a large percentage of angel investments are lost completely when early stage companies fail, professional angel investors seek investments that have the potential to return at least 10 or more times their original investment within 5 years, through a defined exit strategy, such as plans for an initial public offering or an acquisition. Current 'best practices' as taught by the Angel Capital Education Foundation in its 'Power of Angel Investing' seminar series suggest that angels might do better setting their sights even higher, looking for companies that will have at least the potential to provide a 20x-30x return over a five- to seven-year holding period. After taking into account the need to cover failed investments and the multi-year holding time for even the successful ones, however, the actual effective internal rate of return for a typical successful portfolio of angel investments might, in reality, be as 'low' as 20-30%. While the investor's need for high rates of return on any given investment can thus make angel financing an expensive source of funds, cheaper sources of capital, such as bank financing, are usually not available for most early-stage ventures.
Angel investors are often retired entrepreneurs or executives, who may be interested in angel investing for other reasons in addition to pure monetary return. These include wanting to keep abreast of current developments in a particular business arena, mentoring another generation of entrepreneurs, and making use of their experience and networks on a less-than-full-time basis. Thus, in addition to funds, angel investors can often provide valuable management advice and important contacts.
According to the University of New Hampshire's Center for Venture Research, there were 234,000 active angel investors in the U.S. in 2006. Beginning in the late 1980s, angels started to coalesce into informal groups with the goal of sharing deal flow and due diligence work, and pooling their funds to make larger investments. Angel groups are generally local organizations made up of 10 to 150 accredited investors interested in early-stage investing. In 1996 there were about 10 angel groups in the U.S.; as of 2007 there are over 250, with a roughly equal number in all other countries combined. The more advanced of these groups have full time, professional staffs; associated investment funds; sophisticated web-based platforms for processing funding applications; and annual operating budgets of well over US$250,000. In January, 2004 the not-for-profit Angel Capital Association, and later the Angel Capital Education Foundation, were formed under the auspices of the Ewing Marion Kauffman Foundation, bringing together over 100 of the most active angel groups in the United States. The ACA and ACEF have an annual summit meeting each year in a different city, bringing together the leaders of the different groups to exchange best practices. An equivalent European organization, EBAN, the European Business Angel Network, had been established in 1999 by the European Association of Development Agencies (EURADA) with the support of the European Commission.
In 2004, according to the Center for Venture Research, 18.5% of deals that got through the early screens of angel groups and were presented to investors attracted funding. This was up significantly from 10% in 2003, which is about the historical average. But since this figure discounts the tough initial screening performed by most groups, the percentage of all companies seeking angel financing that actually receive funding is closer to 0.5%-1% (but still higher than the 0.2%-0.25% of applicants who receive funding from venture capitalists). Approximately 51,000 US companies received angel funding in 2006, and on average, each raised about US$500,000. Healthcare services, and medical devices and equipment accounted for the largest share of angel investments, with 21 percent of total angel investments in 2006, followed by software (18 percent) and biotech (18 percent). The remaining investments were approximately equally weighted across high-tech sectors