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.
What is an angel investor?
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):
- Angel investors must have annual earnings of at least $200,000 per year for the past two years, with a strong likelihood of similar earnings in the near future. If the angel investor files taxes jointly with their spouse, their required annual earnings increase to $300,000.
- They must have a total net worth of at least $1 million, regardless of marriage and tax filing status.
Some benefits of angel investors include the following:
- Angel investors invest where and how they want. Angel investors assume greater risk compared to banks or venture capitalists. They aren’t beholden to banks or institutions, so they can invest their money as they — and only they — see fit. That means what traditional funders may view as a high-risk business loan and avoid may not be a concern for angel investors.
- Angel investors present less risk for the borrower. As an entrepreneur, you take on less risk with angel investors compared to other funding options. In many cases, angel investors don’t require repayment if your startup fails, making them a less-risky option for growing your company.
- Angel investors have ample business knowledge. Many people wealthy enough to qualify as angel investors earned their money through entrepreneurship. While launching a startup, you may benefit from their business knowledge.
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.
Tip: To find an angel investor, visit the Angel Investment Network website, where you can search for angels and upload your business pitch.
What is a venture capitalist?
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:
- Venture capitalists supply startups with large investment sums. Venture capitalists often make significant investments in companies, so if you need a substantial cash infusion to get started, venture capitalists might be your best funding option.
- Venture capitalists present low risk to entrepreneurs. As with angel investors, venture capitalists often do not require repayment if the venture fails.
- Venture capitalists provide ample knowledge and connections. Like angel investors, venture capitalists have ample relevant experience. They also have myriad connections, such as other investors, industry leaders and helpful third parties.
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.
Did you know? 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.
What are the differences between angel investors and venture capitalists?
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.
1. An angel investor works alone, while venture capitalists are part of a company.
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.
2. Angel investors and venture capitalists invest different amounts.
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.
3. Angel investors and venture capitalists have different responsibilities and motivations.
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.
4. Angel investors only invest in early-stage companies.
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.
5. Angel investors and venture capitalists differ in due diligence.
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.
How to pitch to an angel investor
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:
- Find the right angel investor. Many angel investors specialize in a particular area, so find angels with experience investing in your type of product or industry.
- Have a compelling sales pitch. Pitch an angel investor on what makes your team a winning gamble, but also present key business factors such as your market size, product or service offerings, competitors and their flaws, and, if applicable, your current sales.
- Tell a story to your angel investor. Emotion is key when pitching to angel investors because they’re usually individuals with nobody else to answer to who invest in companies that look innovative and exciting. Craft your narrative, highlighting how you got the initial idea and proved your concept.
- Be descriptive about your vision. Present your ideas to the investor while showcasing the exciting possibilities. Demonstrate your diligence in market research and your passion for the business idea. Use visual media and show physical product creation mockups if you have them. Impress them with your team’s diverse skills, collaboration, shared vision and expertise. Wow them with a well-thought-out startup marketing plan.
Tip: When pitching to an angel investor, show that your entrepreneurial motivation goes beyond making money and that you’re in it for the long haul.
How to pitch to a venture capitalist
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.
- Show how your offering solves a problem. When beginning your pitch to a venture capitalist, present the solution your company provides to a common problem consumers have and how many customers need that problem solved. Prepare a business plan and pitch deck for your meeting, packed with financials, both actual and projected.
- Project your income. During your pitch meeting, you’ll present a four-year projection of your company’s income and expenses. Your goal is to show the venture capitalist that their long-term return on investment mitigates their short-term risk. Have an excellent grasp on the numbers and all the factors that could potentially impact them, up or down, so you can competently answer questions.
- Show barriers to entry. You’ll also need to demonstrate that there are significant barriers to entry, so it isn’t easy for well-capitalized companies to copy your business model and steal your market share. This may include proprietary technology, copyright and patent protection, or exclusive access to a coveted resource.
- Share the business’s growth potential. In addition to gross and net revenue projections, talk about the enormous growth potential of the business. They’ll want to see that your business provides a distinct and unique benefit to its customers and that the potential market size is huge. Be prepared to explain how your company will scale its operations to meet this demand by, say, creating co-marketing relationships with large companies, investing in new locations, and adding manufacturing and inventory storage capacity. Venture capitalists want to invest in companies that are going to have exponential growth so they can get their investment back with plenty of profit within three to five years.
- Be honest about what you’re lacking. If there are areas where the company is lacking in key personnel, vendor relationships or distribution, be honest. Venture capitalists often have these resources at their disposal and will want to know how they can contribute if they decide to invest.
- Don’t give up. Be well prepared, but if the answer is no, don’t give up. Learn from your experience and improve your pitch for the next venture capitalist.
Jennifer Dublino contributed to the reporting and writing in this article.