If you’ve acquired some wealth throughout your life, you may be tempted by the idea of angel investing as a source of income.
Many people consider this route, especially if they have expertise in a particular area (financial management or business development, for example), and it's not hard to see the attraction. Helping innovative entrepreneurs to launch their businesses can be an exhilarating and rewarding process. However, becoming an angel investor is not without its risks.
Angel investment isn't the only way for entrepreneurs to fund a startup, as many business-minded millennials are now realising. Therefore, to understand the risks of angel investing, we must first look at some of the threats to the practice and whether or not they pose serious competition.
What Are the Biggest Threats to Angel Investors?
Here are some of the most significant risks to angel investors in 2018, and why businesses are using them as funding alternatives.
Since many businesses launch online nowadays, it’s not difficult to start up without investment. A new phenomenon called “bootstrapping” is making it easier for new companies to start selling without the need for startup funds. They do this by bartering with other businesses for their products and services.
An example of bootstrapping would be an e-commerce seller approaching a web design agency to create their website for reimbursement through free products. What’s more, with so many free Internet marketing options available, some companies don’t need to spend much money at all to create an online presence and start doing business.
• Credit Cards
Although most financial experts don’t recommend financing a new business on a credit card, many entrepreneurs are getting smart to credit loopholes to make it work for them. By using both their personal and business credit limits to raise startup costs, they avoid doing damage to their credit scores and keep their interest rates in check.
For those who know their way around the financial market, finding credit cards with low-interest rates is easy. Most people also know that they can transfer an outstanding balance to a 0 percent card at the of the loan term, so the credit card battle is a difficult one to win.
• Payday Loans
Again, it may not have been a viable option in the past, but more and more entrepreneurs are bypassing the need for investors by using small cash injections from banks and payday loans instead. Since it’s so easy to apply for payday loans online, it’s a tempting option for a lot of small businesses owners, especially those with good credit who are entitled to larger amounts.
Since the payday loan cap in 2015, interest on all short-term loans is now limited to 0.8 percent per day and one hundred percent in total, meaning no borrower will ever pay back more than twice the amount they borrowed. This has made payday loans a much more attractive option for businesses, creating stiff competition for investors.
• Personal Loans
With one in five 18-34-year-olds quitting their day jobs in favour of launching their own businesses, it’s no secret that we’re in the middle of a millennial startup revolution. How are the majority of these young people funding their small businesses? By borrowing from parents and other family members: an unsurprising turn of events given the disparity in wages and living costs between generations.
Loans from friends and family tend to be interest-free, and there’s usually room for negotiation, so it’s not hard to see why this is such a popular option. The downside for the relatives, however, is that many of these lenders don’t have an accurate picture of the risks involved.
• Personal Assets
Although most new entrepreneurs are advised to keep their personal and business finances separate, many are now using personal assets to help fund their startups. For those who own their own homes, getting a second mortgage or releasing equity on assets could provide immediate access to cash, plus they won’t have to share their companies or deal with creditors. The downside, of course, is that their personal stability is then at risk.
Can You Minimise the Risks of Angel Investing?
Angel investing is a famously risky venture. Many people who enter the practice are worried about low returns or losing their money altogether, and with good reason. Cambridge Associates, advisors to institutions that invest in venture capital, reports that only 3 percent of venture capital firms generate 95 percent of the industry’s returns. Here are some tips to help you minimise those risks.
· Be Worth £1 Million
Only become an angel investor if you're worth at least 200,000 - 1 million per year. This is widely believed to be the minimum amount necessary for someone to be able to withstand the loss of the investment.
· Use 10 Percent of Your Assets
Limit the size of your angel portfolio to 10 percent of your investable assets to minimise the risks of an investment, even if you have the financial wherewithal to invest more.
· Don't Expect Success.
Business startups are not a reliable investment. While the winners tend to win big, 90 percent of startups fail in their first three years. Bear in mind that when a company fails, investors almost never get any money back. This is a risk you need to be willing to take.
· Assume You Will Lose Everything
Assume you are going to lose all your money, and don't invest money you can't afford to lose. Successful venture capital firms generate approximately 80 percent of their returns from less than 20 percent of their investments, so the chances of your angel investments losing bets are high.
Perhaps the best angel investment you could make is choosing the right company to work for, or diversifying and working with several low-risk companies at the same time. A general rule of thumb is never to invest money that you won't need for at least the next five to seven years, ideally ten. However, if you're looking for significant returns within a short timeframe, angel investment might be too risky for you.