—
Startup businesses that have reached a certain stage of development often wonder about their prospects for receiving funding through a venture capital firm or an angel investor. There are some important differences between these types of investors, and it pays to know exactly what you are getting into before committing to an investment.
Dan Lok, a startup expert, explains how angel investors and venture capital firms are similar and different, offering some tips for companies that want to be recognized by these investors.
What is an Angel Investor?
An angel investor is known as a private investor, angel funder, or seed investor. These investors are high net worth individuals who see value in providing financial support to small entrepreneurs and startup companies. Generally, angel investors receive ownership equity in the enterprise. Sometimes, angel investors can come from the business owner’s family or friend group.
Angel investors may inject a significant amount of cash to get a business off the ground. They may also be involved in providing cash at regular intervals to support the growth of the business.
The primary difference between angel investors and regular venture capital firms is that angel investors are more likely to be able to fund an early-stage startup. This is because they are using their own money and do not have a corporate interest. Startups find angel investment attractive because it is less risky than other kinds of funding.
Angel investors have to protect themselves financially, so they typically invest no more than 10 percent of their portfolio in this type of investment. This covers their high risk of failure.
How Much Equity do Angel Investors and Venture Capitalists Get?
There are no hard and fast rules determining how the angel investor’s equity should be applied. The amount of equity that a company must give up is commensurate with what the investor brings to the table.
When angel investors make an early, large, or long-term commitment to the company, they should get more equity. Typical first-round equity includes 20 to 30 percent for an angel investor and 30 to 40 percent for a venture capitalist.
Angel Investors and Company Control
When an angel investor has put money into a project, they reserve the right to take over if the business is failing. This protects their investment to some extent. Angel investors have to be careful that they don’t overspend themselves, and for this reason, they are very choosy about the companies to which they provide funding.
What are the Differences Between Angel Investors and Venture Capital Firms?
Many startup business owners do not understand the difference between an angel investor and a venture capital firm. The primary difference is that a venture capital firm uses money pooled from other investment companies, corporations, and pension funds. VC firms do not use their own money.
Angel investors are accredited investors with at least a minimum net worth of $1 million. They must also have an annual income of $200,000 or more. Fortunately, wealthy friends and family can become angel investors for new businesses.
An angel investor focuses more on the process of building a business than on immediate profit. This might mean that their terms are more reasonable than those of venture capitalists.
Venture capitalists and angel investors also invest at different stages. The type of investor you will appeal to will depend on whether you have an established business or a new one.
A venture capital firm tends to invest in already-proven businesses. This reduces their risk of failure. Typically, venture capital firms begin investing in firms when they are about four years old.
Angel investors are likely to invest in startup businesses. They choose businesses based on their interest and the profit potential, even if the company has not yet proven itself. Angel investors take greater risks but do not invest as much money as venture capital firms.
Angel investors may give your small business enough money to get past the seed stage, but you may want to solicit venture capital firms when your idea has more traction and you have proven successes already.
Different Investment Amounts
The amount of money invested by an angel investor and venture capitalist is different. According to the SBA, the average deal struck by a venture capital firm is about $11.7 million while the average angel investor provides about $330,000.
Return on Investment
Venture capitalists expect a higher rate of return on their investment. They may expect anywhere between 25 and 35 percent. Angel investors are more likely to expect between 20 and 25 percent.
Controlling Stakes
Both types of investors are interested in controlling how you run your business. Since they are funding your company, they may require that you create a board of directors and give them a seat. Venture capitalists are generally not interested in being business mentors.
On the other hand, many angel investors will provide help and advice. This could be a valuable distinction for the small business that needs all the help that it can get.
Choosing Investors
When you understand how angel investors and venture capital firms differ, you will have a better idea about where to pitch your company. In general, angel investors have more favorable terms for early-stage startup companies, where venture capital firms will not even look at them until they have an established profit and customer base.
Dan Lok encourages all startup entrepreneurs to make a solid business plan and an elevator pitch and shop their ideas around. When an entrepreneur is prepared to give up a portion of control of their business, they could stand to see a significant financial benefit.
—
This content is brought to you by Hannah Madison.
Photo: Shutterstock