CHAPTER EIGHT: Part B – Are you about raising funds for your startup but you are torn between approaching an angel investor vs venture capitalist? If YES, here’s a comparison on the best sources of funding for startups.
The greater majority of business startups do need external financing. Granted, a business can kick off comfortably with capital saved up by their founders or from funding from family and friends, but if the business founders have growth and expansion in mind, they must of necessity seek external funding.
The two very popular forms of business funding are angel investors and venture capitalists. Because of the role they play in business financing, many people mistakenly equate angel investing with venture capital financing, but the truth is that they are not the same and they play different roles in business financing.
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What is an Angel Investor?
An angel investor is an affluent individual who provides capital for a business startup, usually in exchange for convertible debt or ownership equity. Angel investors are known to invest in startup businesses who have typically taken their businesses from ideas to standing entities.
Angel investors are focused on helping startups take their first steps, and they sometimes are relations who have big moneybags…well, let’s face it, relations are the first people that know your potentials and can easily be convinced to believe in your ideas.
Angel investors, who are also called informal investors, angel funders, private investors, seed investors or business angels, provide more favorable terms compared to other lenders, since they usually invest in the entrepreneur starting the business rather than the viability of the business.
Things to Know about Angel Investors
- Angels are individuals (or groups of individuals for that matter, who come together) to invest their own money in a business.
- Angels generally invest less money than venture capitalists, typically less or more than a million.
- Angels are often entrepreneurs or former entrepreneurs who have experienced starting, running and growing a business. More than a few are the “millionaire next door” type, rather than people who flash their wealth. Angels may also be professionals, such as doctors or attorneys.
- The degree of involvement angels expect to have in your business varies. Some may want be actively involved, while others prefer a hands-off approach.
- Angels want to make money on their investments, and expect a high rate of return.
What is a Venture Capitalist?
Venture capitalist investors are firms or companies that pool money from groups of investors into a combined fund to invest in emerging businesses. Their primary business goal is to obtain the greatest possible financial return by eventually selling the company they invested in, maybe through mergers and acquisitions, or by holding an initial public offering (IPO).
Things to Know about Venture Capitalists
- Venture capitalists are institutional investors. They manage other people’s money and use it to invest in business ventures. VCs are responsible to the clients whose money they are managing.
- Because they are dealing with money from many investors, VCs generally make larger investments than angels. If you are looking for $3 million or more, getting this amount even from an angel group will be more difficult than getting it from a VC.
- VCs are in a better position to provide multiple rounds of funding as your company grows. If you know you will need more than one round, creating relationships with VCs can be very valuable.
- VCs almost always want to put their own management team in place, and you will need to give up a greater degree of control than you might have to with an angel investor.
- In general, VCs think bigger than angels, and they prefer to work with potentially huge businesses.
- Venture Capitalists love to see facts. If you have prior experience running similar businesses, if you have an experienced management team, if your numbers add up, then you are most likely to get VC funding.
Although both of them are similar in that they will hold private equity from having made investments directly into private companies, there are certain differences between angel investors and venture capitalists. You need to understand these differences to figure out which option is best for your business. Here are major differences between angel investors and venture capitalists:
Angel Investors Vs Venture Capitalists – What’s the Difference
- Angel investors invest mostly as individuals, while venture capitalists are structured companies comprising of several individual investors.
- Angel investors invest their own money into businesses, but venture capitalists invest money contributed by several investors.
- Because they are individuals, angel investors are usually unable or unwilling to fund businesses that require funds above $250,000. Venture capitalists, on the other hand can fund businesses that require millions of dollars, since they are holding funds from several individuals.
- In addition to the invested funds, angel investors usually contribute personal experience and relevant contacts to the growth of businesses they invest in. Some venture capitalists don’t go this far.
- Angel investors may be willing to “hands-off” your business if they have nothing relevant, aside the capital to contribute. But venture capitalists will always require board seats and complex deal terms including the ability to control subsequent financing.
- Angel investors usually require very high ROI because they take very high risks by investing in new businesses that may tank. Venture capitalists usually contribute to already-growing businesses with reduced risk of failure, so they don’t require very high ROI.
- Angel investors tend to believe in the entrepreneur and invest in them as a person. Venture capitalists, being less emotional and more process involved, mainly evaluate deals and make offers.
- Angel investors allow for flexibility in deal structuring and financial decisions; venture capitalists are rigid.
- An angel investor fund businesses for motives beyond financial gains (such as social responsibility and community involvement). A venture capitalist is obligated to maximize investors’ returns and outperform other venture capitalists; in order to attract even more investors.
- Angels tend to avoid follow-up investments out of fear of losing more money should the business fail. Venture capitalists, on the other hand, usually invest additional funds at later stages to assist with growth.
- Angel investors are found in virtually all industries, and they have diversified portfolios. Venture capitalists are involved in limited industries (mostly technology), and they have limited portfolios.
- Help with future fundraising: As full time professional investors with resources and network of the entire firm behind them, venture capitalists are incredibly for future fundraising. A VC’s business is built on connections so they have the ability to see a business into the future, both cash wise and otherwise.
- Stage of Investment: Angel investors typically invest in deals earlier than Venture Capitalists. Angel investors most commonly fund the last stage of technical development and early market entry. Venture Capitalists will then come in with their huge investment to take the company through very rapid growth. VCs will help a company to grow until they are ready to go public or be acquired, so the dollars they invest will be increasingly larger and larger as the rounds progress.
Angel Investors Vs Venture Capitalists – Which is the Best for Startups?
Having noted the characteristics between angel investors and venture capitalists, it is now time to decide which one is the perfect financing method for a startup business. A startup company is a newly emerged, fast-growing business that aims to meet a marketplace need by developing a viable business model around an innovative product, service, process or a platform.
Before a startup company can grow any further, it would need finances to straighten out some teething problems, and from our research so far, angel investors are the right investment partners at this stage of the business. This is because angels are looking to invest in startups and early-stage businesses that are just starting out.
Also, a relationship with an angel investor is not merely a business relationship for financial gains as angel investors lend their business expertise, mentorship and management skills to the company to safeguard their equity position. It is a fact that many startup companies are just getting started and haven’t been able to completely think through all of the aspects of building a business, so this would be a great opportunity to have a professional provide them that much needed advice and direction.
Again, though angel investors may not be able to shell out millions of dollars to companies, but they offer business owners a greater amount of financing than what is available through friends or family. Angels are also great for startups because they provide access to quick funding especially for startups that need access to urgent capital.
It should also be mentioned here that venture capitalists rarely back startups unless the circumstances involved is a unique one, like if the founders are already successful and well-known. Instead, they most often invest in emerging businesses that are more established, seeing them through their growth stages and into IPOs or mergers. So, startups are advised to stay clear of venture capital funding because it is generally only available to companies in their later stages of development.
Before you seek out funding for your new business, you should consult an adviser who is well-versed in the complexities of angel investing and venture capital financing to determine which course of action is best suited for your business.
But you have to know that investors, both angels and VCs, would not invest in any business that is just an idea, so as an entrepreneur, you must have to kick off your business with funds from your savings or from family and friends. You need to make sure that you have something on ground before looking for additional funding.