In order to know which financing option is right for your business, it is important to understand the differences between the two.
To make the right decision for financing your company, you will need to know the intricate differences between angel investors and venture capitalists, and what each can offer.
Small businesses and early-stage companies exist in an exciting economic landscape that offers a lot of opportunities to ambitious entrepreneurs. Depending on the nature of a business and its demands, there are multiple ways of attracting capital. Some startups begin with investments from friends and family until they feel prepared to pursue other sources of capital. Some try crowdsourcing or apply for a small business loan. [If you think a small business loan is right for your business, check out our recommendations for the best alternative lenders.]
More still approach angel investors and venture capitalists to ensure financing for their company. 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 criterion set by the Securities Exchange Commission (SEC):
- Have annual earnings of $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.
- Have a total net worth of at least $1 million, regardless of marriage and tax filing status.
Pros and cons of angel investors
- Angel investors assume greater risk compared to banks or venture capitalists. Angel investors aren't beholden to banks or institutions, so they can invest their money as they – and only they – see fit. That means the investment risks that traditional funders avoid may not be of concern for angel investors.
- As an entrepreneur, you take on less risk 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.
- They require large stakes in your startup. The major disadvantage of angel investors is that their investment often gives them a large stake in your startup, which means you have less control over managing the business.
What is a venture capitalist?
A venture capitalist is an individual or group that invests money into 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.
Pros and cons of venture capitalists
- Venture capitalists supply startups with large investment sums. Venture capitalists often make large 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 – other investors, industry leaders, helpful third parties – that they utilize.
- Entrepreneurs have less control over managing the business. Venture capitalists often require a controlling interest in your startup, effectively removing you from full leadership.
What are the differences between angel investors and venture capitalists?
As two of the most common alternative sources of funding, angel investors and venture capitalists have several similarities. Both angels and venture capitalist firms cater to innovative startup businesses, and both tend to prefer companies related to technology and science. That being said, there are some important differences between venture capitalists and 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 rich, 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, it's highly unlikely 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. They invest different amounts.
If you're looking into the possibility of approaching a venture capitalist or an 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, you should note that, 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. They have different responsibilities and motivations.
Angels investors are primarily there to 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 that holds a strong competitive advantage, a talented management team and a wide potential market. Once venture capitalists are convinced and have invested, it is then their role 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 will be on hand to advise and act as a sounding board for CEOs. This is all with the aim of helping 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 the late-stage technical development and early market entry. The funds an angel investor provides can make all the difference when it comes to getting a company up and running.
Venture capitalists, on the other hand, invest in early-stage companies and more developed companies, depending on the focus of the venture capital firm. If a startup shows compelling promise and a lot of 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 what it takes to succeed. The venture capitalist then offers funding to allow for rapid development and growth.
5. They differ in due diligence.
Due diligence is an area that has provoked a lot of debate for angel investors over the years. Some angels do almost no due diligence – and they aren't really bound to, given that all the money 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 can spend in excess of $50,000 when it comes to 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.
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.
How to pitch to a venture capitalist
When pitching 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.
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.
Additional reporting by Max Freedman.