Angel investment: Why invest in early-stage startups?

By Luis O’Cleiry, Co-Founder and CMSO, LastBasic

After difficult times resulting from the pandemic, startups around the globe were delighted to experience a funding boost in 2021. By the end of the year, $29.1 billion had been invested by business angels, marking an increase of 15.2% on the previous year.

At present, angel investment remains a viable option as we move through the end of 2022. Given that global inflation is predicted to rise to dizzying heights of 7.5% by the end of the year, money from venture capitals (VCs), government grants, and other traditional sources could be drying up.

Angel investors are a vital lifeline for early-stage startups seeking rapid growth. The benefits for angels themselves are significant too, ranging from significant returns on individual investments to strengthening their overall portfolio by contributing to innovation within their chosen industry. The relationship between angel investor and startup should therefore be one of mutual gain, whereby the angel can increase their asset value, and the startup can grow its business.

Business angels: A vital lifeline for the global startup ecosystem

The number of startups is increasing every year, with almost 5.4 million applications to form a new business filed in the USA alone in 2021. A majority of these companies are seeking to disrupt a traditional industry, bringing an innovative model to an existing market. But, in order to do so successfully, these businesses need funding, and relying on one single source alone is rarely sufficient.

Business angels take a significant risk when investing in early-stage startups. The price of investing is generally much lower than investing in more mature companies, but the risk is also significantly higher. Angels are investing in a business which doesn’t yet have much market share, and is not guaranteed to succeed. So, why take that risk?

Trust in the potential of early-stage businesses

Angel investing is riskier than other asset classes, and is less liquid, but has significant potential to offer greater returns in the long-run. Angel investors are said to expect a 30-40% return on investment, making investing in early-stage businesses a highly attractive asset class for many.

Business angels are also often able to acquire a larger stake in the businesses they invest in. The early-stage organisations to which they pledge their capital generally have cheaper shares than more mature companies. Consequently, angel investors can afford to grab a larger piece of the pie, and receive higher returns down the line. There will always be a risk associated with this, but if the risk pays off, the investor will receive a much bigger chunk of the profits when the company scales up and multiplies its value. Investing in smaller companies can therefore bring a significant return on investment – with risk, comes reward.

Reaping the unique returns on investment

Inevitably, there are other benefits to investing in early-stage startups for business angels. Angel investors tend to be those with significant experience in their industry, who have perhaps already seen personal success in starting, managing, and growing businesses. Typically, they take a more altruistic approach to investment as a result, seeking to impart their knowledge to founders in the form of advice and strategic direction.

Angels tend to truly believe in the businesses and industries they support, whether that be by investing in green energy or digital transformation, for example. As such, angel investors often invest in impact startups, otherwise known as businesses which aim to build solutions to the United Nations Sustainable Development Goals. Such startups in the UK attracted a record £2 billion investment in 2021, marking a firm commitment to sustainable business growth. Angels want to back businesses that are contributing to the greater good of society, and in return, will experience reputational benefits derived from having a socially conscious portfolio.

Finally, angel investors are known for chasing after innovation. Startups can be among the most innovative businesses on the market, as they seek to contribute something new to their chosen industry. As such, those who invest in early-stage businesses are often directly contributing to innovation. When doing so, not only can investors acquire a sense of pride in contributing towards progress, but they support the market’s development as a whole. Then, if investing in other businesses within the same market, investors can ensure that their whole portfolio brings strong returns.

As the number of startups conceived continues to climb, it is likely that more and more investors will take a chance on smaller businesses. The potential is astronomical and goes beyond mere financial gain. Those who get ahead of the game and invest early are those most likely to reap the highest reward.