When starting a business, entrepreneurs often don’t have enough of their own money to bankroll their endeavor and must look to third parties for financing. If you don’t want to apply for a business loan, you’ll need to find an equity investor.
There are various types of equity investors, including angel investors and venture capitalists. Each has its own perspective, priorities and benefits. Knowing the difference between angel investors and venture capital investors is necessary to make the right decision for your business going forward.
An angel investor provides a large cash infusion of their own money to an early-stage startup. In return, the angel investor receives equity or convertible debt.
Many angel investors are accredited, though not all are. Accredited investors must meet one of the two following criteria set by the U.S. Securities and Exchange Commission (SEC):
Some benefits of angel investors include the following:
The primary downside of angel investors is that they require a large stake in your startup, meaning you have less control over managing the business.
A venture capitalist is an individual or group that invests money in high-risk startups. Typically, the potential for the startup to grow rapidly offsets the potential risk for failure, thus incentivizing venture capitalists to invest. After a set period, the venture capitalist may fully buy the company or, in the event of an initial public offering (IPO), a large number of its shares.
Some benefits of venture capitalists include the following:
The primary downside of venture capitalists is that they allow entrepreneurs less control over managing the business. Venture capitalists often require a controlling interest in your startup, effectively removing you from full leadership.
Private equity and venture capital are both alternative funding measures. However, while venture capitalists tend to focus on high-growth companies, private equity focuses on more stable and mature businesses.
As two of the most common alternative funding sources, angel investors and venture capitalists have several similarities. Both cater to innovative startup businesses, and both tend to prefer companies related to technology and science. However, there are some crucial differences between venture capitalists and angel investors.
Angel investors, sometimes known as business angels, are individuals who invest their finances in a startup. Angels are wealthy, often influential individuals who choose to invest in high-potential companies in exchange for an equity stake. Given that they are investing their own money and there is always an inherent risk in doing so, it’s doubtful that an angel will invest in a business owner who isn’t willing to give away a part of their company.
Venture capital firms, on the other hand, comprise a group of professional investors. Their capital will come from individuals, corporations, pension funds and foundations. These investors are known as limited partners. General partners, on the other hand, are those who work closely with founders or entrepreneurs; they are responsible for managing the fund and ensuring the company is developing in a healthy way.
If you’re looking into approaching a venture capitalist or angel investor, you’ll need an accurate idea of what they’ll be able to provide financially. Typically, angels invest between $25,000 and $100,000 of their own money, though sometimes they invest more or less. When angels come together in a group, they might average more than $750,000.
While angel investing is a generally quick solution, because of their relatively limited financial capacity, angel investors can’t always finance the full capital requirements of a business. Venture capitalists, on the other hand, invest an average of $7 million in a company.
Angel investors primarily offer financial support. While they might provide advice if you ask for it or introduce you to important contacts, they are not obliged to do so. Their level of involvement depends on the wishes of the company and the angel’s own inclinations.
A venture capitalist looks for a strong product or service with a strong competitive advantage, a talented management team, and a vast potential market. Once venture capitalists are convinced and have invested, their role is to help build successful companies, which is where they add real value.
Among other areas, a venture capitalist will help when it comes to establishing a company’s strategic focus and recruiting senior management. They’ll be on hand to advise and act as a sounding board for CEOs. This helps a company make more money and become more successful.
Angel investors specialize in early-stage businesses, funding late-stage technical development and early market entry. An angel investor’s funds can make all the difference in getting a company up and running.
Venture capitalists, on the other hand, invest in early-stage companies as well as more developed companies, depending on the focus of the venture capital firm. If a startup shows compelling promise and growth potential, a venture capitalist will be keen to invest.
A venture capitalist will also be eager to invest in a business with a proven track record that can demonstrate it has everything necessary to succeed. The venture capitalist then offers funding to allow for rapid development and growth.
The idea of due diligence has provoked a lot of debate among angel investors over the years. Some angels do almost no due diligence — and they aren’t bound to, given that the money they invest is their own. However, it has been shown that when angel investors do at least 20 hours of due diligence, they are five times more likely to see a positive return.
Venture capitalists need to do more due diligence, given that they have a fiduciary responsibility to their limited partners. Venture capitalists sometimes spend in excess of $50,000 when researching their investment prospects.
An angel investor may be more interested in your startup’s ideas or team than its immediate potential for profit. Here are some tips when pitching to an angel investor:
While an angel investor pitch leans more heavily on “the sizzle,” pitches to venture capitalists rely more on presenting “the steak,” or the numbers of your business. Here are some tips for pitching to a venture capitalist.
Jennifer Dublino contributed to the reporting and writing in this article.