Dangers in angel investing

Angel investors are funding much of the current startup boom, but startups should do their homework before signing over equity.

From left: Paul Sloan, Paige Craig, Naval Ravikant, David Tisch James Martin, CBS Interactive

With so many millionaires minted by companies like PayPal, Google, and now Facebook, angel investing has become a big deal, particularly in tech. But some of the more seasoned investors are apprehensive about participation from newcomers.

Investors Paige Craig, David Tisch, and Naval Ravikant discussed the topic of angel investing in a panel led by CNET executive editor Paul Sloan. The group agreed that many investors have no business investing.

According to Ravikant, there are, "too few sophisticated investors," and he'd know. As the founder of AngelList, a network that connects startups with angel investors, he's vetted thousands of would-be angel investors.

In just two years, the site has grown to 3,500 active angels, but that's nothing compared with how many have been rejected. Ravikant said that more than 8,000 potential investors have been turned away from participating on AngelList.

Tisch feels that there are a number of investors currently operating who are outright predatory. These individuals take substantial equity in their investments but provide very little worth to the startups. The issue here is that angel investing is unlike traditional venture capital.

Companies take investments from angels not just because they need operating capital, angels are often former entrepreneurs with valuable insights and connections. When a startup and an angel team up, the ideal relationship sees the angel providing guidance and connections in addition to money.

Tisch sees a lot of investments. He serves as managing director for TechStars New York, an accelerator launched in 2011 under the TechStars umbrella. TechStars takes a 6 percent stake in a startup for $100,000 and three months in one of its four accelerator programs across the U.S.

Many would say that the value comes more from participation in the accelerator than from the $100,000. TechStars dispels any predatory notions by offering an equity-back guarantee. If a startup participates and doesn't feel that it's gotten value from the program, TechStars will return the 6 percent of equity.

While Craig believes that there are indeed a number of carpetbaggers taking advantage of needy startups, the onus really falls on the companies. Startups might not always do the necessary due diligence when seeking cash. Which seems logical, but first time entrepreneurs seldom have experience taking money from strangers. But he says that there's an easy solution for that.

When his company BetterWorks was pursuing capital, his team and his investors spent a lot of time together to make sure the relationship made sense. "It's important to actually understand your investors," said Craig. "Take money from investors who you want to hang out with."

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