Could You Be an Angel Investor?

How to earn your wings providing seed money to a worthy upstart.

Angel with palm branch, Bavaria, Germany.
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Until recently, angel investors seemed a bit ethereal. Rarely seen, their influence in providing seed money for promising concepts and entrepreneurs was taken on faith. But in the past five years, angels have come down from the clouds to organize and to track their results. As with all investments, the devil is in the details. These down-to-earth tips will help you sort through the if, how and when of becoming an angel investor.

To be an angel, you must have enough money to get off the ground. According to the Securities and Exchange Commission, that means you have to be able to afford to lose your entire investment – typically $10,000 to $50,000 in a single start-up. To be an "accredited investor," and thus approved by the SEC to be an angel (or to put money into other nontraditional investments), you must have either a net worth of $1 million or an annual income of at least $200,000.

[Read: 5 Things You Should Ask Your Financial Advisor.]

The rule of thumb is that about half of startup companies fail. According to the U.S. Census Bureau, the five-year survival rate for businesses started in 2000 was only 50.7 percent. Data from the Bureau's Center for Economic Studies shows that the survival rate has barely hovered above or dipped below 50 percent since 1989. A quarter of startups return 5 percent or less, and the final quarter earn 7 percent or more, according to Angel Resource Institute's 2013 Halo Report, which collects information from more than 200 angel investor groups.

The "home run" investments must be so successful that they more than make up for the complete loss and mediocre performance of the others. That's why even accredited investors should channel no more than 10 percent of their total portfolio into this high-risk category, says Troy Knauss, president of the Angel Resource Institute in Overland Park, Kan.

You can further minimize risk by joining a network that shares information and syndicates deals, says Jean Peters, a managing director with Golden Seeds, an angel consortium that focuses on women-run investments and a board member of the Angel Capital Association in Overland Park, Kan. If you invest in just one or two startups, odds are that they will deliver little or no return. But if you invest in slices of several start-ups, you'll improve your chances of being in one of those home runs. Syndication is the mechanism that lets lots of angels get slices of lots of deals.

"It's incredibly important to have a portfolio," Peters says. "You have to spread your risk. We expect our investors to build a portfolio of 10 to 12 investments over time, to create an expectation of significant net positive return."

Syndicates have reshaped how angels invest. In the past, angels found each other through informal networks. Now there are organized consortiums that invest in regions, industries and, as with Golden Seeds, by investment philosophy.

These consortiums do more than look at deals. They serve as peer mentors, industry experts and sources of data for their own deals. Many of these groups belong to the Angel Capital Association, which aggregates data submitted by the groups to track the return on angel investments. The University of New Hampshire's Center for Venture Research, part of the Peter T. Paul College of Business and Economics, also tracks trends. It found that angel investing was up 5.2 percent in the first half of 2013 compared with the same period in 2012, and that – big surprise – technology startups were the top category.

[Read: In Alternative Funds, Female Managers Excel.]

Angels flock together, Peters says, because they need each other's inside perspective and expertise. Are you thinking of investing in a great concept but don't know much about the industry? Someone in your network will know.

Angels almost always become board members and actively guide entrepreneurs in the nuts and bolts of turning their big ideas into business reality. That means angels must be adept at strategy, collaboration and coaching. "This is full-contact investing," says Jeffrey Sohl, director for the Center for Venture Research in Durham, N.H. "You have to be involved and perform due diligence."