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A Guide to Angel Investments: Assessing Value and Cash Flow

Making angel investments can be very lucrative. But angel investors need to have a strong understanding of the key principles in order to maximize success while minimizing risk.

Angel investments are different than most other types of investing. They’re typically made by wealthy individuals who provide capital to start-up companies in exchange for an equity stake rather than a fixed return on investment. While this can lead big returns, it’s also very risky. The majority of new businesses fail and don’t end up providing financial return on investment to capital providers.

In order to track and value your investments appropriately, angel investors need to understand the following key principles:

1. The difference between book value and equity value

The book value of an asset is its accounting value or historical cost. For angel investments, this is the amount you originally paid. The equity value of your investment is how much your shares would be worth in a liquidation or acquisition. This may be significantly less than the book value because many new businesses fail. If partners don’t agree about how much an angel investment is worth, they may not reach an agreement.

2. Reasonable valuations and dilution

In order to accurately value your angel investments, it’s important to set reasonable valuations that are based on an objective analysis of the company. While this may not be possible in some cases, using a conservative estimate is better than basing your valuation on optimistic speculation.

Ways to accurately value your angel investments include comparing the company’s performance with industry benchmarks or using valuation multiples like price-to-earnings ratios.

It’s also important to consider dilution. This is how much your percentage ownership will decline when you invest in additional companies or provide new capital to the existing one.

3. Cash flow and returns

Typically, angel investments are made during the early stages of a company’s life cycle, which means that you’re not likely to receive an income stream in return for your investment. However, you should still monitor the cash you receive from the investment because it’s important for determining your total return on investment.

One way to measure this is by multiplying the company’s revenue by the percentage of revenue that you’re entitled to as an investor. This can give you a rough idea of how much money you’ll make if the business succeeds. You should also monitor any changes in the overall value of your investment, which is typically based on an assessment of the company’s progress towards its goals.

Angel investors in startup setting.

4. Potential for tax benefits

If you’re operating as a business, angel investments may qualify for tax benefits. This can help considerably reduce your taxes when filing your returns. Some common types of tax benefits include depreciation, which can help you offset income from your angel investments with the decline in their value over time, and expensing items like start-up costs.

5. The risk of loss

While there are several benefits to investing as an angel, it’s important that you understand the risks. Of course, the goal is to minimize the chances of making a poor investment.

One serious risk is that you lose your entire investment. This may result from bad management decisions or even bankruptcy.

Another consideration is the difficulty of tracking and valuing angel investments. Tracking performance can be time-consuming and make it more difficult for you to properly assess your overall financial situation. For example, some new businesses negotiate a valuation cap or other restrictions on your investment during negotiations. It’s important to familiarize yourself with the terms of your angel investments.

6. Using a platform to track your investments

We covered how difficult tracking and managing these investments can be. One way to simplify managing angel investments is by using a platform such as AltExchange. We’ll track performance for you in real-time and collect all your important documents including K-1s, all in one place.

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