Your feedback is essential to help us improve - click here to take our 3 minute survey.

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

Taking a gamble? What are the top 3 mistakes for an angel investor?
Image source: Getty Images

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?

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?

Chantelle 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, Chantelle 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.’”

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 Chantelle 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.

Chantelle 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.”

Rated 5 stars out of 5 by The Motley Fool UK

Trade UK shares for just £2.95 and US shares for just $3.95 — with no platform fee!

The FinecoBank* Multi-Currency Trading Account offers UK investors highly competitive share-dealing rates across 26 global markets. Open your account using promo code TRD500-ML and during your first 3 months you can trade without incurring commission charges – up to a total commission amount of £500. (Terms and conditions apply.)

*Affiliate Partner. Important information and risk disclaimer: The value of shares and any income produced can fall as well as rise, and you may get back less than you invest. Exchange rate fluctuations can reduce the sterling value of any overseas holdings.

Was this article helpful?

Some offers on The Motley Fool UK site are from our partners — it’s how we make money and keep this site going. But does that impact our ratings? Nope. Our commitment is to you. If a product isn’t any good, our rating will reflect that, or we won’t list it at all. Also, while we aim to feature the best products available, we do not review every product on the market. Learn more here. The statements above are The Motley Fool’s alone and have not been provided or endorsed by bank advertisers. John Mackey, CEO of Whole Foods Market, an Amazon subsidiary, is a member of The Motley Fool’s board of directors. The Motley Fool UK has recommended Barclays, Hargreaves Lansdown, HSBC Holdings, Lloyds Banking Group, Mastercard, and Tesco.