China's venture capital (VC) industry is booming with overseas investors entering the Chinese market and domestic venture capital enterprises rapidly coming of age. While many grow-stage and late-stage Chinese enterprises have received capital from active mainland investors, some early-stage start-ups find it difficult to obtain initial financing, which reflects the still fledging nature of the VC industry in China.

Since the late 1980s, international angel investors have formed various kinds of U.S.-based networks to increase investment volume and reduce risks by sharing project resources and mutually conducting due diligence.

According to the recent Angel Investment Report published by the U.S. Center for Venture Research, a total of 258,200 active angel investors in the U.S. invested US$26 billion in 57,120 enterprises in 2007, with an average of US$455,000  per investment, an increase over 2006 levels. As for VC investment, a total of 3,813 enterprises received US$29.4 billion in 2007.

In China, angel investment is gradually capturing the attention of the media and the business community, but still lacks official guidance and a low-level organizational structure. Indeed, a large number of angel investors operate in China, while a batch of entrepreneurs who were once backed by angel investors and venture capitalists have joined their ranks after selling or merging their companies. Notable Chinese angel investors include Neil Shen, Feng Deng, Jason Jiang, Yongqiang Qian, and Hongyi Zhou, all of whom have invested in enterprises with great potential value in the start-up or seed stage.

Nevertheless, domestic angel investment is still in its infancy. Only about 100 angel investors are active in China, yielding fewer deals at lower stakes.

Accredited Investors

In order to cement their standing in China, domestic angel investors should maintain a similar accredited investor status with that outlined by U.S. law. The U.S. federal securities laws define an "accredited investor" as:

， A director, executive officer, or general partner of the company selling securities
， Someone who has individual net worth, or joint net worth with the person's spouse, that exceeds US$1 million at the time of the investment
， Someone with income exceeding US$200,000 in each of the recent two years or joint income with his/her spouse exceeding US$300,000 for those years and a reasonable expectation of the same income level in the current year

This mandatory stipulation helps the investment-receiving enterprise avoid legal complications when obtaining follow-on VC investments or when pursuing an exit strategy, including an IPO. If an investor is not accredited pursuant to the federal securities laws, the U.S. Securities & Exchange Commission (SEC) will carefully investigate the previous stock shares held by the investor and ask the company to take immediate steps to remedy past violations of the federal securities laws, thus delaying, suspending, and even derailing the company's IPO strategy.

In general, angel investors in China have common traits, including:

， Aged 30-60
， Annual income in excess of RMB 500,000 and current assets in excess of RMB 5 million
， Proven experience in building enterprises
， Willingness to conduct long-term investment (five to seven years)
， Willingness to work with the founders in an advisory role
， Investment in familiar industries
， Obtaining investment opportunities through others¨ recommendations

Additionally, angel investors should offer value-added services in the fields of business operation, sourcing, and follow-on financing, and others. For example, if an attorney acts as an angel investor, he or she will often offer pro-bono legal services to help the company reduce costs.

Currently, executive officers of privately owned and listed companies, and heads of privately owned companies with VC partners comprise the majority of the angel investors in China. According to Hongyi Zhou, ideal angel investors should be familiar with the industry, have company-building experience and possess a wide network of business contacts to help provide companies with strategic guidance and opportunities for follow-on financings.

Preferred Stock Investment and Convertible Debt Investment

Angel investors should conduct sufficient legal and market research before offering financing, after which they can pursue preferred stock or convertible debt investment options.

First, standard valuations are not available. In general, the pre-money valuation for an angel investment project ranges from RMB 1 million to RMB 20 million. David Beer, who operated a U.K.-based angel investment network alliance for more than 20 years, says an idea worthy of ♀10,000 will be valued at ♀100,000 if it is well managed, and the value will increase to ♀500,000 if the investors sell the project to the suitable person. 

Secondly, angel investors can choose preferred stock (common stock) or convertible debt as options for return on the investment. Preferred stock is similar to the pre-VC investment in the form of stock shares, without the provisions that limit angel investors rights typically included on VC investment term sheets. A typical angel investor can hold a 25% to 50% stake in a start-up by injecting RMB 500,000.

Convertible debt allows for the dual nature of debt and options. It can ensure that angel investors receive agreed-upon interest, usually about 6% to 8%. This type of investment also gives angel investors the option to convert bonds into shares. When financed (usually in first-round financing), the company will permit angel investors to buy shares at a 25% to 40% discount.

Angel investors often take the following measures to protect their rights when they adopt convertible debt investment:

， The price discount rate will be adjusted if founders fail to get follow-on financings within a specific time. For instance, if a founder can not succeed in obtaining follow-on financing within six months, the price discount rate will from 25% to 35%.
， Control the valuation cap in advance to prevent the investor from losing the discounted shares rate when the enterprise appreciates.

Tips on Becoming an Accredited Angel Investor in China

Angel investors bear larger risks in China due to the uncertainty of the domestic policy environment and regulation, asymmetric information between entrepreneurs and investors, and the lack of genuine communication between angel investors and VC investors.

Given these precarious conditions, individuals seeking to become accredited angel investors in China must first identify a suitable start-up enterprise. In general, promising start-ups have some common features, including:

， A strong founding team with unique expertise and technology
， An innovative business model or product that is still in the developmental stage, or an operation or business model that has been proven by the market (data regarding website clicks or sales turnover may be available)
， A fresh industry, which may not arouse VC's attention but has strong potential
， Founders that have wholly devoted themselves to the business and do not have external projects competing for time and resources. 
， The demand for funds isn't great, from RMB 100,000 to RMB 10 million

The following issues need to be clarified with the founders when discussing an investment:

， The division of ownership and controlling rights
， Deadlines for the company to generate sufficient profits, often between three to seven years
， The size of returns offered to investors
， Advisor hierarchy - investors or the board of the directors
， The existence of an exit plan within three to seven years

Further advice for angel investors:

， Cooperate with other angel investors. Since the late 1980s, various types of angel investor networks have emerged in the U.S. The Directory of Angel Investors has a list of such networks. Try to avoid conducting angel investments alone. Create an angel investors syndicated investment team to avoid excessive risk.
， It is necessary for both angel investors and VC investors to conduct due diligence before formally investing. Parties should hold in-depth talks with the entrepreneurial team to develop a proper working relationship. For any investment, the team is the most crucial element of success. In addition to studying the business plan, it is important to investigate the proposed team. A trustworthy person is more important than a business model. For example, among all the IDGVC deals, only Home Inns has retained its original business model. In the  eyes of the angel investor, the business model can be improved, but finding a trustworthy founder is the foundation for a successful enterprise.
， Be prepared to provide founders with various services. The purpose of conducting investment is to obtain high returns. To this end, investors must offer their services, become advisors to the founders while respecting their judgment, and give them support when necessary.
， Investors should protect their rights. When conducting investments, angels should first consider helping the company obtain follow-on financing and effectively communicate with future VC investors. Accordingly, it is necessary to help founders frame the overall financial plan. Nevertheless, angel investors need to protect their own interests and prevent the dilution of their shares.