Angel Investor vs. Venture Capitalist

Today, there are a number of ways for startups and small businesses to secure funds. Depending on the nature and scale of businesses, some may raise capital by borrowing money from friends and family while others may turn towards small business loans or crowdfunding.

However, majority of the entrepreneurs still rely on getting their funds from angel investors and venture capitalists, especially if their business isn’t qualified enough to receive traditional loans.

Before moving forward you must decide whether you are going for an angel investor or a venture capitalist. To do that, you must know the differences between the two.

They do have some similarities such as giving priority to innovative startups and preferring ventures related to technology and science, however, there are many things that sets them both apart.

Let’s take a look at the most pressing differences between angels and VC firms below.

• Stage of investment

Angel investors are specialized in providing funds for startups. They are willing to take on the risks that come with a brand new business. Their investments are typically used to cover startup expenses and the rest to be used as working capital during the first year.

Venture Capitalist firms, on the other hand, only invest in startups that show compelling financial projections and growth potential. Most of the time, they invest in businesses with a proven track record and which are already generating a decent amount of profit.

• Investment amount

Since angel investors focus only on providing seed funding for startups, you won’t be able to see the kind of figures you would expect from a VC firm on paper.

A single angel may invest up to $100,000 in a startup while a group of angels may invest as much as $1 million.

Keep in mind that angel investors, even as a group, won’t be able to fulfill the capital requirements of some businesses due to their limited financial resources.

Venture capitalist firms, on the other hand, have enough resources to invest as much as $7 million on average in a single deal.

Now you may feel like turning towards VCs but remember that large investments come with great expectations. This will put a lot of pressure on your small business and may hinder its short-term goals.

Also, be very careful about overvaluating your business. You will face a lot problems down the road if you do.

• Source of funds

Angel investors are rich and influential individuals who are willing to provide seed funds for startups they are interested in and has huge growth potential.

One of the main differences between angels and VCs is that angels fund startups using their own money whereas venture capitalists invest money belonging to various individuals, institutions, corporations and pension funds.

• Responsibilities and motives

The sole purpose of an angel investor is to provide financial support for new ventures. Yes, they may provide financial and management advices, and introduce you to important influential people if you ask them to, however, they are not obligated to do this.

They can be as hands-off or hands-on as you want, assuming that they are fine with/without being involved. Besides, you can’t blame them for not wanting to be involved because they only have equity, not a seat on the board.

Venture capitalists, however, are responsible for the success of your company. They will help you when it comes to things like deciding on new marketing strategies or recruiting senior management.

Their purpose is to make sure your business grows and becomes more profitable so that they can get high returns on investment.

While this is helpful, it’s an overkill for a startup. There are many decisions to be made and altered in the starting stage of any business so waiting for the approval of investors for each and every decision will just slow things down.

• Due diligence

Typically, angel investors don’t do due diligence since the funds being invested are their own. However, it has been shown that when angels do perform at least 20 hours of due diligence, there was almost always a positive return.

Venture capitalist firms, on the other hand, are required to do due diligence since they are handing over funds belonging to their limited partners. They are the individuals, institutions and corporations who put money in venture capital funds. Whereas the people who actually invest and work with you are called general partners.

The job of VCs is to find businesses with huge growth potential and good management, and trade equity shares for funds. They typically ask for a seat on the board as well.

Then they will work together with you, helping the business grow and become more profitable with the expectation of receiving a high return on investment.

Once they are satisfied with the return, they will try to sell the shares back to the original owner for a much higher price.

As you can see, venture capitalists need to make sure that your business is well worth the investment, and the best way to do that is by doing due diligence. This may cost as much as $50,000 in addition to the investment amount, and may take around 1-3 months to complete.

Angel investors, however, are able to take quick decisions since they work alone, invest their own money, and invest only in businesses with a personal interest.

Here are three of the most important questions that need to be addressed when performing due diligence.

• Is the entrepreneur and his team up for the task? Can they be trusted?

• Are any existing or potential customers who would buy such a product or service? If so, how many?

• How much capital does the company really need?

• Board involvement

Individual angels do not ask for a seat on the board, however, if a group of angels get involved, one of them would want to sit on the board in order to represent the investors’ interests. Naturally this would be the biggest contributor of them all.

VCs, on the other hand, require a seat on the board. Not just any seat but the seat of the angel. The angel investor may then continue to stay on as a non-vote observer or may just retire from the board altogether.

• ROI

Some say that both, angels and VCs expect a high ROI. However, in my opinion, angels require a higher ROI than venture capitalists since they take on a lot of risks by investing in new businesses. VCs, on the other hand, invest money in already growing businesses, and thereby avoiding the majority of the risks.

• Follow-up investments

Angels usually avoid follow-up investments, fearing that they may loose their money. However, venture capitalists often put additional investments when capital is low, in order to assist with the company growth.

Conclusion

Both, angel investors and venture capitalists expect you to give away a decent amount of shares in exchange for the investment. Angels are often easy to impress whereas VCs are not, especially if your business is still in the startup stage.

Take your time to create a compelling, detailed but short pitch to get investors’ attention and secure the funds you need. If your startup is really innovative and has huge growth potential, you may even be able to secure funds from a VC.

Venture capitalists do aid in the management and decision making of your business, however, you would be giving up a seat on the board right from the get-go. Let in too much external power on the board and you may see yourself being fired someday.

The question of whom to approach should be answered yourself. After all, this is your business. As a general rule of thumb, go for angel investors if you are a startup and go for venture capitalist firms if you have an already existing profitable business which requires a large amount of capital.

Who would you choose? And why? Comment down below.