How to Be an Angel

The stealth recovery that began almost two years ago has finally become evident with last quarter's surprisingly strong 2.4% GDP growth rate. It's also apparent in the panic prevailing in the gloom-loving bond pits on Wall Street, where traders have sent long-term interest rates soaring. With times getting better, you would think investing would be getting easier. But nothing looks cheap. Even after steep declines, many stocks remain expensive relative to earnings. Bonds are a death trap during periods of faster growth. Real estate never fell. Money-market yields barely cover a fund's expenses. So you have to look beyond the traditional stocks-bonds-cash-real estate mix to find any broad investment categories that are truly bargains.

But there is one area of promise: angel investing, which in the past has also been known as investing with friends, family and fools. If you ever cut Cousin Lou a check to finance his tattoo parlor, you know what I mean. But angel investing has come a long way in recent years, enabling well-heeled and business-savvy investors to get a meaningful stake on the ground floor of a variety of promising start-ups. Although Cousin Lou may tempt you with free tattoos (think of the possibilities), you can get stakes in a dozen or so new companies vetted for their potential by investing $75,000 to $150,000 in an angel fund.

Why now? Private-asset values have taken a beating in the recession, and start-ups are desperate for financing. Four years ago, a typical $100,000 angel investment would have bought a 0.5% stake in a new company. Now the same investment probably buys a 2% to 5% stake, and you're investing at the bottom of the cycle. Don't expect a swift payback, however. Angel investments may remain illiquid for five to 12 years, which could encompass two or even three economic cycles. But the odds of long-term success are best if a company starts during a recovery and finds its footing before the next downturn. (Fees for angel funds run at 1% to 2% of assets, and as with hedge funds, the managers take 10% to 20% of the profits.)

Angel investors are essentially venture capitalists their investment will either pay off big in the long run or lead to the kind of tax deduction no one ever wants (as in flop). The main difference is that angel investors provide seed money, usually on the basis of a business plan. Venture capitalists have provided such funding in the past but are now so large that they will not get involved until an operation is up and running and seeking to get to the next level.

With angel investing, though, you can exact control over management. Indeed, the typical start-up looking for angel funding wants it from people who can help as board members or advisers. "The perfect candidate is a retired, successful entrepreneur who can provide valuable counsel," says Christopher Starr, managing director of Innovation Philadelphia, a regional economic-development group that finds financing for entrepreneurs. A perfect set of 10 angel investors throwing in $100,000 each to reach the $1 million mark that many start-ups want would include one or two attorneys, accountants, consultants, bankers and industry executives, along with some silent investors, Starr says.

The high stakes and potential for failure rightfully keep most folks from being angels to a single company. If you're going to give it a try, make sure you have an attorney well versed in private equity draw up the agreement, clearly spelling out any role you may have on the board and your rights if there is a change in management (in which case, you want the right to sell). Angel clubs, modeled on the informal investment clubs that became so popular among friends in the '90s, are popping up in many cities and often are eager to add investors who have some expertise. For information, check the websites angelsummit.org and nasvf.org .

If you're interested, there are a few angel funds raising money, including the Mid-Atlantic Group Angel Fund cstarr@ipphila.com ), Nashville Capital Network nashvillecapital.com ) and South Florida Angel fund newideacenter.com ). This is serious hands-on investing, but at least you know you're getting in cheap.