Is Angel Investing a Good Way to Build Wealth?
(Bloomberg Opinion) -- Look around and you’d see a digital-era gold rush. There’s hype about cryptocurrencies, NFTs and GameStop-gate, not to mention the continued rise of the stock market, which many are watching through their Robinhood apps. Although some people will amass wealth through these assets, there is another form of investing that’s piqued my interest as of late.
In researching different ways to build wealth, I was struck by the opportunities VC and angel investors have for not only generating returns but also shaping the future.
The average stock market investor is only picking from companies that are publicly traded. But VCs and angels who invest at earlier stages have the chance to help a company reach an exchange in the first place. They can fund ventures with innovative ideas that other investors might not see and back companies created by underrepresented founders in the startup world.
If you’re looking to help shape the future of an industry and our economy, as well as build wealth, investing in startups is an actionable — albeit highly volatile — way to achieve your goal.
One issue, however, is access. As is often the case in wealth building, it takes money to make money. Angel investors are generally required to be “accredited investors.” For decades, the threshold for being accredited in the U.S. meant you needed either a net worth of $1 million, excluding a primary residence, or an individual income of at least $200,000 in each of the two most recent years ($300,000 for those filing jointly). In December 2020, the SEC expanded the definition to allow “natural persons to qualify as accredited investors based on certain professional certifications, designations or credentials or other credentials issued by an accredited educational institution, which the Commission may designate from time to time by order.”
However, there is a discussion about whether the net worth and income requirements are too low for today’s climate. One angel told me she felt these were too low for those in expensive cities because one would need to invest more to be adequately diversified. She’d prefer to see $5 million as the net worth minimum.
Here’s the rationale. A 2017 survey found the median investment by an American angel was $25,000 per round to a single company. Now, let’s say you need to invest in at least 10 companies to be a diversified angel investor. That’d be a quarter-of-a-million dollars, which could mean 25% of someone’s net worth. Considering the volatility of the investments, even when properly diversified, that’s entirely too much risk. The prevailing rule of thumb is to not have more than 5% of your portfolio in speculative investments.
But although it makes sense to ensure investors are property diversified, this cap is incredibly restrictive. Demanding a $5 million or even $1 million net worth effectively blocks people from what can be impactful wealth building opportunities.
Fortunately, things are changing. Much like fractional shares changed the ability to invest in stocks, technology is opening up more opportunities for individuals to take advantage of angel investing. Enter equity crowdfunding.
Plenty of millennials are familiar with crowdfunding via platforms like GoFundMe or Kickstarter, where people ask for money to start a business or help with unexpected expenses, and funders donate without expecting any ownership in the project or repayment. Equity crowdfunding operates along a similar principle in that you pool your money with anonymous strangers on the Internet, but in this case it’s to fund a company.
The big difference is, you get an interest in the business. It’s akin to contributing to an index fund or fractional shares. You own a small slice of equity, depending on how much you invest.
Equity crowdfunding comes in two common forms: accredited, which is defined the same way as above, and open-access regulated, which is open to anyone who can legally invest. Sites like Republic and WeFunder offer the regular, non-accredited investor (like me) a chance to give angel investing a try. The type of security can vary based on the startup. For example, Republic offers Crowd SAFE (Simple Agreement for Future Equity), Token Purchase Agreements for Blockchain-related projects and Crowd Simple Debt Agreements.
When considering how much to invest, it’s critical to remember that this should only be a speculative part of anyone’s portfolio. Settle on an amount of money you’re comfortable losing to the cause of funding a company you believe should exist and to — let’s be honest — the hope of making some money as well.
Don’t forget that you’re just as likely to lose significant money or see your stake diluted overtime. Stats on startup failures run the gamut, but an oft-quoted one is that 90% fail in the first three years. Even if you were to be optimistic and say 50% — that’s still good odds you’d lose your money.
I think attempts to democratize angel investing through equity crowdfunding are worthwhile because they point to a world where it’s not only the wealthy determining which startups live or die based on who gets funding. This doesn’t mean early-stage investing is the right route for everyone or that it will yield more than dashed dreams of funding the next Google or Facebook or Uber. But it’s a compelling option if you want to put (a small percentage of) your money to work.
This column does not necessarily reflect the opinion of the editorial board or Bloomberg LP and its owners.
Erin Lowry is the author of “Broke Millennial,” “Broke Millennial Takes On Investing” and the forthcoming “Broke Millennial Talks Money: Stories, Scripts and Advice to Navigate Awkward Financial Conversations.”
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