Angel investing is an exciting journey, but like any adventure, you need to be well-prepared. Together, let's talk about getting your finances in shipshape before you dive in.
Let's focus on 10 financial steps you should take to set yourself up for angel investing success; consider these your angel prerequisites.
1. Assess Your Current Financial Health
Before you start writing checks to startups, it's essential to take a hard look at your current financial situation. Create a detailed inventory of your assets, liabilities, and monthly cash flows. Understanding where you stand financially will help you determine how much “investable assets'' you have. This is the total amount of money you have to invest across all asset classes.
Most angel investments are open to accredited investors, defined as:
- Individual income over $200,000 or $300,000 jointly with spouse or partner, over the prior two years and reasonable expectations to be able to maintain that level.
- Net worth over $1 million, excluding primary residence. The value of second homes, cabins, or investment properties can however count toward your net worth. Nerd Wallet has a straightforward net worth calculator or your financial advisor likely has a worksheet to help tally up your assets and liabilities.
- Investment professionals in good standing, holding the general securities representative license (Series 7), the investment adviser representative license (Series 65), or the private securities offerings representative license (Series 82).
- Other measurements for accreditation based on employment can be found here.
To read more about accredited investors check out our blog post: What the heck is an "Accredited Investor" anyway?
2. Establish an Emergency Fund
Life is full of unexpected surprises. Before you consider angel investing, make sure you have a robust emergency fund in place. It acts as a financial safety net, ensuring that you can handle unexpected financial challenges without jeopardizing your investments. Do not use your emergency fund to make angel investments.
3. Pay Off High-Interest Debt
Not all debt is bad; but high-interest debt, such as credit card balances, can erode your financial stability and limit your capacity to invest in the future. Before you start early-stage investing, prioritize paying off any high-interest debts. Ultimately reducing your debt burden will free up more of your income for investments in the long run.
4. Build a Liquid Investment Portfolio
Before diving into illiquid angel investments, ensure you have a well-rounded portfolio of liquid assets. Those could include stocks, bonds, or mutual funds that can be easily converted to cash if needed. You will likely be utilizing traditional accounts like a 401K, IRA, or Roth to build this out.
And while we are on the subject of your retirement account, if your employer offers a matching program, get that free money and max that out!
While there may be some tax penalties, the money in these accounts are liquid. This will provide you a solid base as you explore more illiquid assets, like angel investing.
5. Set Clear Investment Goals
If you have the above handled, you are likely in a position to start adding in other assets, like angel investing, to further diversify your investment portfolio. Before we go there, you should ask yourself what you are hoping to accomplish with your investments. When thinking about this, consider things like risk appetite, investment horizon, and personal goals.
Angel investing in particular is a high risk, illiquid, long term investment (think 10-ish years). This should be aligned with your goals and balanced out with your other investments.
6. Seek Professional Advice
As needed, consider working with a tax advisor, financial advisor, and/or attorney who specializes in angel investing. They can help you create a strategic investment and tax plan, evaluate opportunities, and ensure contractually you are poised for success.
7. Diversify Your Investments
Diversification is key to managing risk in your portfolio. With your traditional investments covered (step #4), you can now look into other asset classes like real estate, angel investing, private equity, and beyond based on the goals you’ve identified (step 5). As a general guideline, angel investments should be less than 20% of your total investable assets.
Within the subset of your early-stage investment portfolio, you should also consider diversification. Avoid putting all your capital into a single startup. Instead, spread your investments across multiple startups, aiming for a portfolio of 10 or more. For more reading on this topic, Daren Cotter, fellow angel investor, gets into the power of probability in this Angel Basecamp article.
8. Review Your Tax Situation
Understanding the tax implications is important. Minnesota offers a 25% credit to investors or investment funds that make qualifying in Minnesota-based startups. The maximum credit is $125,000 per person, per year ($250,000 if filing jointly). This helps stretch out your angel investment budget.
Consult with a tax professional to evaluate how your angel investments may impact your tax liability and to ensure you are utilizing tax credits and incentives to the maximum.
9. Create a Budget
Building an angel investment portfolio requires discipline, but first you need to figure out how much you can consistently invest. How you drive at this number can be based on a percentage of your annual income, investable assets, or net worth. The focus is less about the amount, rather setting a clear target. Let’s call this your angel investment budget.
With your angel investment budget, you will want to divide that across multiple startups.
Angel investment budget / number of startups = target check size
Using real numbers, let's say you have $100,000 to invest in the next two years. Two options might make sense for you:
- Direct angel investing: $100,000 / 10 startups = $10,000 target check size
- Invest as an LP in an early stage venture fund: $100,000 minimum investment, drawn down over the fund’s deployment schedule (typically 3 to 4 years)
Knowledge is power in the world of angel investing. Groove makes it easy to connect and learn from other early-stage investors. Groove has a network of 200+ investors, making it easy to exchange ideas and continuously educate yourself about startup trends, emerging technologies, and market dynamics. You can also attend Angel Fest and other networking events to stay informed locally.
Remember, angel investing is a long-term commitment that can be rewarding when approached with financial prudence and a well-thought-out strategy. So, my fellow Minnesotan, get your financial ducks in a row, and you'll be well on your way to becoming a successful angel investor.