An investor who wants equity in a company can buy its shares on a public stock market. Or, as an angel investor, they can put their money into early-stage startups in exchange for an equity stake.
Angel investing is a type of private equity financing. Angel investors are typically wealthy individuals who use their own capital to support new, small businesses. They invest when the risk of failure is high and traditional venture capitalists or banks won’t provide funding. In return, angels generally receive an equity or ownership stake, which can yield big returns if the company thrives and is sold or goes public.
Some startups backed by angels ultimately end up as public companies and trade on a stock exchange. Ride-hailing service Uber, for instance, was founded in 2009 and received angel funding in 2010, raising $1.3 million. Subsequent venture capital investments made Uber the world’s most valuable startup with an valuation of $51 billion in 2015. Even though the company had a disappointing initial public offering (IPO) in May 2019, when it began trading on the New York Stock Exchange, Uber’s angel backers recouped their original investments many times over.
What are the similarities between angel investing and stock market investing?
Individuals deciding between making an angel investment and buying stock in a public company have several goals in common. They seek the following:
- Growth opportunities. Both early-stage and established companies that trade on a stock exchange offer the potential for growth and, ultimately, profits. Individuals can assess both investments by determining how well the companies’ products, services, and visions address needs in their respective markets.
- A company with successful management. Companies can succeed or fail based on the talent of their management. That’s true for those companies still on the drawing board. Investors can evaluate the managers of public companies through their public statements, filings, and other readily available information. Angel investors typically can evaluate the management team of startups when the founders pitch their idea in meetings and interviews.
- Profits. Profits are a major goal for both angel and stock market investors. Both can reward investors with big gains if they bet on the right company and are willing to wait. Microsoft went public in 1986. A person who invested $1,000 in its shares would have amassed more than $3.7 million as of April 2022. Angel investments can take a decade or more to pay off through an IPO or sale—but the profits for investors with equity stakes can be huge in either case.
What are the differences between angel investing and stock market investing?
There are critical differences between angel investing and investing in the stock market—particularly the substantial risk of failure for early-stage companies. Among the things investors might consider are:
- Public vs private information. Early-stage companies often don’t have a track record of profit or revenue. In fact, they may not even have an operating business. Investors must look to other types of data, including the company’s burn rate—or how fast it’s using up its funding. This information is confidential and not available to the general public, so investors will have to trust the startup’s own reporting on it. Public companies, in contrast, must report their financial status each quarter and disclose any material or important events to the Securities and Exchange Commission (SEC). This information is available to the public.
- Development risk. Angel-funded companies are in the early stages of creating their product or service. They may face technical snafus, unanticipated roadblocks, market shifts, and other obstacles. There is no guarantee that the company’s business will work as the founders envision—if at all. Public companies already operate a business and have a track record. While they may encounter glitches, their basic concept and execution have proven to produce a working product or service.
- Liquidity. Angel investors agree to have their money locked up for years. Once they commit, they cannot cash out their investment. Stock investors can buy and sell their shares at any time–even if it means having to sell them for less than they paid.
- Likelihood of generating returns. At least half of all early-stage companies fail, meaning angel investors can lose all the money they invested. To be successful, angels often build a portfolio of 10 or more startups and expect most to go bust or break even and one to possibly hit it big. Stock investors also can lose their entire investment if the price of their shares goes to zero. However, this is less common than it is with angel investing. It’s even less likely for investors in mutual funds or exchange-traded funds (ETFs) that bundle stocks, especially when the funds track an established index, such as the Standard and Poor’s 500.
- Dividends. Many companies pay dividends that can substantially increase the returns on an investment. Dividends account for as much as 40% of the total average historical stock market returns, though this can be much higher when stock prices are underperforming. By comparison, angel investments don’t pay dividends, and any cash a startup might generate is reinvested into expanding the business.
How to evaluate an angel investment
Angel investors don’t usually have a lot of hard data to review. But they can assess a startup by asking key questions to find candidates with the highest chance of success. The questions can cover:
- Vision. Do the startup’s business and plans align with my interests, vision, and philosophy? Do I believe in the vision and think the idea will succeed in the future?
- Founders. Do I have confidence in the founding team? Can the business succeed without this team? What is their track record?
- Products and services. Is there demand for the product or service that might lead to future profitability? What has the rollout been like so far?
- Disrupting or defining. Is this business disrupting an existing category, or defining a new one? What hurdles might there be to driving adoption of their product or service?
- Advantages. What advantages does this business have? Who are the competitors and how threatening are they? What is the marketing strategy to challenge them?
- Returns. How will the founders meld their interests with those of investors? How will the business make money and what is the potential return on investment for backers?
How to evaluate a stock investment
Stock market investors have a different set of questions to ask themselves when considering a company’s shares or a bundle of stocks in a mutual fund or ETF. They have reams of public data to go on, including:
- Earnings. Which way is the company’s earnings growth trending? Does the company have a proven strategy to increase sales, attract new customers, and develop new products to keep profits growing?
- Competitors. What is the company’s strength compared to its peers? What is its market share? Does it have a special quality that helps it stand out?
- Debt. What is its debt-to-equity ratio and does the company earn enough to repay its debt? Is the company’s debt similar to others in the industry?
- Price. How well does the company’s stock price reflect its earnings? What is its price-to-earnings (P/E) ratio, a reflection of how much investors are paying for each dollar the company earns?
- Management. How effective are the company’s executives? Are they transparent and trustworthy?
- Stability. Is the company showing stable growth? Has it regularly increased dividends? Has it weathered downturns and come back stronger?
From investing in stocks to angel investing
An active stock investor picks shares by studying a company’s financial results, analyzing its market, and putting their money into the businesses they determine have the best chance of success. The same principles apply to angel investors. But in these cases, the individual is not just betting on a company’s future. Because they’re involved in the early stages of a company, they deal with management and can influence strategy in the new venture.
All sorts of people invest in the stock market. Angel investors, in contrast, are typically wealthy business people who have succeeded in past ventures and overcome setbacks in their professional careers. They are usually accredited investors who meet certain income and net worth levels. Their experiences and network of contacts are useful to a young company and can help entrepreneurs work through obstacles.
Those who have invested in stocks need different skills in the angel arena. They’ll need to broaden their research techniques and recognize that data will be scarce. They'll have to deal with legal contracts and do their own due diligence. And they’ll have the responsibility of knowing that their investment and input can help make or break a young company.
The bottom line
Individuals who are considering angel investing will find similarities to investing in the stock market. Both can yield substantial profits based on the fortunes of a company or group of companies. Both involve picking businesses with strong management in markets where they have a competitive edge. Angel investing involves more risk of failure than stock investing. Startups don’t have a track record and backers can lose their entire investment. Stock investors can suffer losses too, though rarely will their entire investment be wiped out.