This is one of the most common questions we receive at the Angel Investing School; How do angel investors make money?
Before jumping into how angel investors make money, we have to remember one thing: angel investing in startups can be risky. The likelihood of a startup being successful is 10% and therefore never forget the most important rule before investing: Don’t invest money you cannot afford to lose.
So let’s take a look at how investors make money:
There are two ways to do so: either the startup is getting acquired or going public. This means that the investor can expect after this event to get a return on their investment. This can happen through a one-time payment or through a series of payments over time.
However, there is a reason why angel investing can be risky and it is important to be aware of those risks. Even when a startup is getting acquired or goes public, there is no guarantee that an investor will even see 1x their money i.e. get the money back that they initially invested (you invest £500 and get £500 back).
How is that possible? Let’s look at an example! In 2021, I invested £500 in Citymapper through Crowdcube. Crowdcube is an equity-crowdfunding platform, which makes it simple for investors to buy shares in Europe’s high-growth private businesses. On the 16th of March 2023, Crowdcube sent out an email that Citymapper was acquired by Via. Below are extracts of the email that lays out the return investors received after investing in Citymapper.
“Citymapper and its shareholders (together, the “Sellers”) have entered into a definitive agreement (the share purchase agreement or the “SPA”) whereby Via has acquired 100% of Citymapper for a combination of cash and Via stock. The consideration per share for nominee investors is forecast to be up to £0.80 per share. The share price at the time of the crowdfunding round was £2.71 per share and therefore unfortunately represents a negative net return for nominee investors.”
In simple terms, this means that the return is less than the investment that was made by the investor. Why? Because Citymapper was acquired for a valuation less than the valuation when they raised funding on Crowdcube.
In the current structure, Crowdcube investors have common stock with no liquidation preference.”
When an investor has common stock with no liquidation preference, this means that there are other investors (typically VC investors) who have priority over you (angel investor) to get their money back. Having a liquidation preference as an investor is a very handy tool for example when a company goes bankrupt, you have priority over other investors to get your money back. So when money is returned to investors, first investors with liquidation preference get their money back followed by investors with common stock.
“Illustratively, if you invested £1,000 in Citymapper, you own 369 shares in Citymapper. You can expect to receive a total of up to £303 in proceeds from the Transaction over the next 18 months. Three months after closing of the Transaction you will receive £87 in cash and £82 in Via common stock. Additionally, 18 months after closing you will receive up to £122 in additional cash and £12 in Via common stock, pending final closing adjustments. Note that £116 of this additional cash is dependent upon the successful receipt of tax refunds related to the pre-closing operations of the Company, as referenced previously. The remaining £6 of additional cash and £12 in Via equity is held in escrow, and is to be released after 18 months subject to there being no claims under the SPA.”
This means that after having invested £500, I had to half all the numbers above to get an estimated return on my investment.
This means that as an investor I owned approximately 184 shares in Citymapper, £151.50 in proceeds from the Transaction over the next 18 months and 3 months after closing I will receive £43.50 in cash and £41 in Via common stock. Additionally, 18 months after closing I will receive up to £61 in additional cash and £6 in Via common stock, pending final closing adjustments. Note that £58 of this additional cash is dependent upon the successful receipt of tax refunds related to the pre-closing operations of the Company, as referenced previously. The remaining £3 of additional cash and £6 in Via equity is held in escrow and is to be released after 18 months subject to there being no claims under the SPA. SPA stands for sales and purchase agreement and there are no disputes over this agreement.
This example shows that being an angel investor can be risky and even if a company is successfully acquired that doesn’t guarantee that a return will be made on the investment. Therefore, before angel investing, carefully consider all the risks and benefits. Check out as well our latest article on what other mistakes to avoid before angel investing.