Taking a gamble? What are the top 3 mistakes for an angel investor?

Angel investing is a risky business and can lead to expensive losses. Alice guy investigates the top 3 angel investor mistakes and how they can protect themselves.

The content of this article was relevant at the time of publishing. Circumstances change continuously and caution should therefore be exercised when relying upon any content contained within this article.

Senior woman looking through the window at home

Image source: Getty Images

When investing, your capital is at risk. The value of your investments can go down as well as up and you may get back less than you put in.

Read More

The content of this article is provided for information purposes only and is not intended to be, nor does it constitute, any form of personal advice. Investments in a currency other than sterling are exposed to currency exchange risk. Currency exchange rates are constantly changing, which may affect the value of the investment in sterling terms. You could lose money in sterling even if the stock price rises in the currency of origin. Stocks listed on overseas exchanges may be subject to additional dealing and exchange rate charges, and may have other tax implications, and may not provide the same, or any, regulatory protection as in the UK.

You’re reading a free article with opinions that may differ from The Motley Fool’s Premium Investing Services. Become a Motley Fool member today to get instant access to our top analyst recommendations, in-depth research, investing resources, and more. Learn More.

Angel investors offer a lifeline to small business owners. They invest their hard-earned cash in start-up businesses that can’t get funding elsewhere. In exchange, they often expect a share of that small business.

It’s a big risk! If angel investors get it right, the rewards can be amazing. But if they get it wrong, they risk losing their whole investment. It’s certainly not for the faint-hearted!

Here I take a look at the top three mistakes made by experienced angel investors. What have they learned from their errors?

[top_pitch]

1. Taking everything at face value

We’ve all seen Dragon’s Den. “I’m in – I’ll make you an offer!” the Dragons exclaim when they want to invest in a fledgling business.

But that’s only the beginning of the process. After the pitch comes the due diligence. That’s where the Dragons pour through the business’s financial information to find out if the pitch was accurate. What are the sales figures? What does the business owe? How much cash does it have? Are there any nasty surprises the angel investor should know about?

Chantelly Arneaud from Envestors (an investment platform connecting investors and entrepreneurs) warns that even that due diligence sometimes isn’t enough. Business owners can sometimes hide significant problems from an angel investor. She spoke to one angel investor who “recounts how a business failed to disclose that it owed a six-figure sum in VAT. This detail, when included, showed the business to be insolvent.” If the business goes bankrupt, the angel investor loses all their money.

To protect themselves, Chantelly advises that investors should “always work with organisations regulated by the Financial Conduct Authority (FCA). The FCA’s regulations are designed to protect the investor and require firms to ensure information is, ‘clear, fair and not misleading.’”

[middle_pitch]

2. Not checking who owns the intellectual property

Intellectual property (IP) rights mean that the pitching business has exclusive rights to sell its product. Without IP rights, there’s a risk of copycat products being launched. Intellectual property can include inventions, literary and artistic works, designs and symbols, and names and images.

Angel investors don’t want to spend their time and money helping to build up a business only to have it copied by someone else.

But even if the business owner has the intellectual property rights for their product, angel investors still need to watch out. They should check that the business owns the intellectual property rather than the business owner themselves. That’s because the angel investor could be ripped off if the business fails. According to Chantelly Arneaud, there’s a risk “that if the business folds, the founder can walk away with the IP and set up an identical business in which you have no shares.”

3. Putting all of their eggs in one basket

Angel investors often prefer to invest in business sectors they know well. But that can come with its own problems. Anyone who only invested in restaurant businesses had a tough ride during the Covid crisis and subsequent lockdowns.

Chantelly advises that “to minimise risk, [angel investors should] build a diverse portfolio. Experienced angels know some investments will go bust, others will stagnate, and a few will skyrocket. Ensure you’ve got enough spread to balance the risk.”

Should you invest, the value of your investment may rise or fall and your capital is at risk. Before investing, your individual circumstances should be assessed. Consider taking independent financial advice.

More on Personal Finance

Note paper with question mark on orange background
Personal Finance

Should you invest your ISA in a model portfolio?

Which model ISA portfolios offer both high performance and low fees? Hargreaves Lansdown, Interactive Investor and AJ Bell go under…

Read more »

Economic Uncertainty Ahead Sign With Stormy Background
Personal Finance

Is it time to exit emerging markets investments?

Investors may well be sitting on losses from emerging markets funds. Is it worth keeping the faith for a sustained…

Read more »

Personal Finance

Share trading? Three shares with turnaround potential

Share trading has been difficult in 2022, but which companies have turnaround potential? Jo Groves takes a closer look at…

Read more »

Man using credit card and smartphone for purchasing goods online.
Personal Finance

Revealed! Why Gen Z may be the savviest generation when it comes to credit cards

New research reveals that Gen Z may be the most astute when it comes to credit cards. But why? And…

Read more »

Environmental technology concept.
Personal Finance

The 10 best-performing sectors for ISA investors

The best-performing sectors over the past year invested in real assets such as infrastructure, but is this trend set to…

Read more »

Road sign warning of a risk ahead
Personal Finance

Recession risk ‘on the rise’: is it time for investors to worry?

A major global bank has suggested the risk of a recession in the UK is 'on the rise'. So, should…

Read more »

pensive bearded business man sitting on chair looking out of the window
Personal Finance

1 in 4 cutting back on investments amid cost of living crisis

New research shows one in four investors have cut back on their investing contributions to cope with the rising cost…

Read more »

Image of person checking their shares portfolio on mobile phone and computer
Personal Finance

The 10 most popular stocks among UK investors so far this year

As the new tax year kicks off, here's a look at some of the most popular stocks among UK investors…

Read more »