Angel Investors Vs. Venture Capitalists

Angel investors and venture capitalists are both essential parts of the startup funding ecosystem. But what, exactly, are they? And how are they different? And how do you know which one you should turn to when you’re raising money for your startup?

March 29th, 2019   |    By: The Startups Team    |    Tags: Angels

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How are angel investors different from venture capitalists?

We’ll get into the details of the differences between angel investors and venture capitalist below, but here’s a wide angle of view first:

Angel investors are wealthy individuals (or groups of wealthy individuals) who invest their own money into companies.

Venture capitalists (VCs) are employees of venture capital firms that invest other people’s money (which they hold in a fund) into companies.

Now let’s take a closer at the two, before diving into the specific differences.

What are angel investors?

Angel investors are typically high net worth individuals who invest very early into the formation of a new startup company, usually in exchange for convertible debt or equity. The role of angel investors serves as a critical bridge between the startup financing needs of a company and their larger capital needs later on.

Angel investors invest their own money, so it can come from a variety of sources. Maybe they sold their own startup. Maybe they made a lot of money in another industry. Maybe it’s family money. There’s no one “where” that we can point to as a primary source of funding for angel investors.

In order to be an angel investor, a person does not have to be an accredited investor. However, a lot of angel investors are accredited investors.

In order to be an accredited investor, according to the Securities Exchange Commission (SEC), a person must:

  • Have made at least $200,000 a year (or $300,000, for a couple) for the past two years and must have the expectation of making that amount again

OR

  • Have a net worth over $1 million, either alone or together with a spouse (excluding the value of the person’s primary residence).

Pros of working with angel investors

One big advantage of working with angel investors is the fact that they are often more willing to take a bigger risk than traditional financing institutes, like banks.

Additionally, while the angel investor is taking a bigger risk than a bank might, the founder is taking a smaller risk, as angel investments typically don’t have to be paid back if the startup fails.

As angel investors are typically experienced business people with many years of success already behind them, they bring a lot of knowledge to a startup that can boost the speed of growth.

Many startup founders are learning everything from scratch, so having that kind of knowledge on the team is a huge advantage.

Cons of working with angel investors

The primary disadvantage of working with angel investors is that founders give up some control of their company when they take on this type of private investment.

Angel investors are purchasing a stake in the startup and will expect a certain amount of involvement and say as the company moves forward.

The exact details of how much say the angel investor gets in exchange for their investment should be outlined in the term sheet.

What is venture capital?

Venture capital is financing that’s invested in startups and small businesses that are usually high risk, but also have the potential for exponential growth.

Pros of venture capital

Venture capital is a great option for startups that are looking to scale big — and quickly. Because the investments are fairly large, your startup has to be prepared to take that money and grow.

The biggest advantage of working with venture capital firms is that if your startup goes under — as most do — you’re not on the hook for the money because unlike a loan, there’s no obligation to pay it back.

Venture capitalists come to the table with a lot of business and institutional knowledge. They’re also well-connected with other businesses that could help you and your startups, professionals that you might want to take on as employees, and — obviously — other investors.

Cons of working with venture capitalist firms

While you don’t technically have to “pay back” venture capital, venture capital firms are expecting a return on their investment.

That means that a startup that accepts VC money needs to be planning for an exit of some kind, usually an acquisition or an IPO. If that’s not your goal — or if you see yourself running your startup forever — then venture capital is not for you.

On that note, part of what venture capitalists want in return for their investment is equity in a startup. That means that you give up part of their ownership when you bring on venture capital.

Depending on the deal, a VC may even end up with a majority share — more than 50 percent ownerships — of a startup. If that happens, you essentially lose management control of your company.

Differences between venture capitalists and angel investors:

###Favored industries: venture capital

Venture capitalists also tend to migrate toward certain industries or trends that are more likely to yield a big return. That’s why it’s common to see so much venture capital and angel investment activity around technology companies: They have the potential to be a huge win.

VCs know that for every 20 investments they make, only one will likely be a huge win. A win for a VC is either one of two outcomes – the company they invested in goes public or is sold for a large amount.

VCs need these big returns because the other 19 investments they make may be a total loss. The problem, of course, is that the VCs have no idea which of the 20 investments will be a home run, so they have to bet on companies that all have the potential to be the next Google.

Conversely, other types of industries may yield great businesses, but not giant returns. A landscaping business, for example, may be wildly successful and profitable, but it’s not likely to generate the massive return on investment that a VC needs to make it’s fund work.

The other reason VCs tend to invest in a few industries is because that’s where their domain expertise is the strongest.

It would be difficult for anyone to make a multi-million dollar decision on a restaurant if all they have ever known were microchips. When it comes to big dollar investing, VCs tend to go with what they know.

Favored industries: angel investors

Angel investors tend to invest in companies that are in industries they know a lot about.

So, for example, if an angel investor made a lot of money in the real estate industry, you can imagine they would be most comfortable putting money back into that industry.

After all, they know the industry, including the right questions to ask, what kinds of opportunities exist — and who’s BS’ing them.

That’s not to say that it’s the only criteria for angel investors. They may have made their money in gold mining, but are looking to make investments in tech companies because they think that’s where the big upside opportunity is.

While you wouldn’t want to count out an angel investor who didn’t come from your industry, you would definitely want to seek out those who might have a built-in affinity to your industry first.

Process: Angel investors

Angel investors usually come on early in the life cycle of a startup. One of the reasons they’re called “angels” is the fact that they’re willing to put money into pre-valuation startups, which may have a hard time finding funding sources elsewhere.

So how do you value a company that doesn’t have any metrics yet?

One way is to really emphasize the team, rather than any numbers or metrics. Angel investors are particularly interested in investing in the founder, with less of a focus on current profit or sales, which are often non-existent for early stage startups.

However, that doesn’t mean angels are only investing in the founder. They’re also looking at more quantifiable terms, like the size of the market your startup is in, the product itself, how competitive the environment is, and — yes — whether the startup has any marketing or sales yet.

As a founder, it’s your job to convince the angel investor that you are the person to run this company and that this company is going to be a a serious player in the field.

Angels are often one of the more accessible forms of early stage capital for an entrepreneur and as such are a critical part of the equity fundraising ecosystem.

There is no definitive limit on what a single angel investor can invest, but a typical range would be from as little as $5,000 to as much as $5,000,000, although most angels tend to cap out around $500,000.

Angels may also invest incrementally, offering founders a small investment now with the opportunity to follow-on at a later date with additional investment, typically when something important happens with the business.

Getting good angel investment deal structures is all about creating a win-win situation. Once a founder gets an angel investor interested in their deal and agree on basic terms, they will need to discuss the best way to structure the investment.

Process: Venture Capitalists

The goal of a venture capital investment is a very high return for the venture capital firm, usually in the form of an acquisition of the startup or an IPO.

A venture capital firm is usually run by a handful of partners who have raised a large sum of money from a group of limited partners (LPs) to invest on their behalf.

The LPs are typically large institutions, like a State Teachers Retirement System or a university who are using the services of the VC to help generate big returns on their money.

The partners have a window of 7 to 10 years with which to make investments, and more importantly, generate a big return. Creating a big return in such a short span of time means that VCs must invest in deals that have a giant outcome.

These big outcomes not only provide great returns to the fund, they also help cover the losses of the high number of failures that high risk investing attracts.

Other funding sources

But angel investors and VCs aren’t the only form of startup funding! Be sure to check out our other guides to startup funding below:

Types of Small Business Grants

Series A, B, C, D, and E Funding: How It Works

What is Crowdfunding?

Types of Crowdfunding: Donation, Rewards, and Equity-Based

Private Investors for Startups: Everything You Need to Know

Convertible Notes (aka Convertible Debt): The Complete Guide

Small Business Startup Loans: What You Need to Know

About the Author

The Startups Team

Startups is the world's largest startup platform, helping over 1 million startup companies find customers, funding, mentors, and world-class education.

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