Making the decision to take your business to the next level is a huge step, and there are many different paths you can take. One of the most common decisions entrepreneurs have to make is whether or not to work with a business angel or a venture capital firm. So, which is the right choice for you? Let's take a look at the pros and cons of each.
While venture capitalists work for a risk capital firm and invest other people's money, angel investors are typically wealthy individuals who finance startups with their personal funds.
Early stage startups with promising business ideas are more likely to receive large investments from angel investors than from VC firms, who typically focus on a company's growth potential.
On average, VC firms invest more money than angel investors do. However, in exchange for this larger investment, the VC firm will get a higher equity stake in the company in the long-run.
Among the most crucial distinctions is that VC firms typically necessitate having some control over operations, whereas angel investors incline to stay passive. While direct control is not possible, VCs have was of enforcing conditions before funding and often get a board seat. Angels can also get a board seat, but their role is more passive.
Angel Investors
An angel investor is an individual, accredited and usually affluent, who invests their own money in a startup or company in its early stages of development; this is given in exchange for equity in the startup. Angel investors may also contribute their business expertise and network in the industry to support the startup's growth.
Pros and cons of angel investors
Given that angel investors are independent from banks or other institutions, they can invest their money more freely, as in, riskier investments.
Business angels invest in the early stages of start-ups, which means that the investment is associated with a high level of risk, as future success is still uncertain. In return, investors secure shares in the company with small contributions and can profit from growth in the long term.
As many angel investors are successful entrepreneurs themselves, they can offer valuable insights and knowledge to help you launch your own startup.
A downside to working with angel investors is that they usually want a large ownership stake in your startup, especially at the beginning, so it’s a big dilution for the founders. This gives Angels a big chunk of the eventual exit proceeds.
Venture Capital investments and Venture Funds
Compared to business angels, venture capital companies are institutional investors that pursue a strict exit strategy. Generally, venture capitalist become involved in the fundraising process after angel investors have already invested. As with other investments, those who provide venture capital usually receive an equity percentage of the company they've funded. Typically the equity stakes VCs get is nominally less than what Angels got, but since it is at a later stage, and they can acquire more in subsequent rounds, in the long run, they end up with a higher proportion after dilution.
Most of the time, people or organizations that want to venture into capital funding will set up a firm with a limited partnership (LP) design. In this partnership, the responsibilities and duties of both investors and management are outlined precisely and usually distinguished from each other. The VC firm's shareholders who invest in the company are called its limited partners, while those employed by the firm to manage it are known as general partners. It is essential to grasp that these investors are not employees of the company but "outside investors" like how hedge fund managers work.
Limited partners for a venture capital firm can be professional investors, like pension funds and wealthy accredited individuals, but that isn't always the case. The VC firm also has its own employees - separate from the investors - who's goal is to help facilitate growth for businesses that receive funding from the venture capital fund.
Although it is not necessary, the managing partner in a VC firm can also be an investor. Their primary purpose is to use the pooled funds wisely and turn a profit.
If you want to read more about venture capital funding, check out our guide: "venture capital funding: a beginner's guide“.
Pros and cons of venture capitalists
If you're a startup in need of substantial funding, venture capitalists could be your best bet. They are known for making large investments into companies.
Venture capitalists are a great source of knowledge and connections. Like angel investors, they have plenty of relevant experience to offer. They also have access to a wide network of people – other investors, industry leaders, helpful third parties – that they can tap into.
If you're an entrepreneur, one of the downsides with venture capitalists is that you'll have less control managing your business. If you take money from venture capitalists, they often require a controlling interest in your startup which removes you from full leadership.
Differences between angel investors and venture capitalist
Individual vs. fund
An angel investor is someone who invest in businesses they like, usually with their own money. Venture capitalists manage a pool of other people's money in a fund that is professionally managed.
Early-stage vs. established businesses
Capital investors tend to focus their efforts on businesses in different stages of development. Business angels typically invest in younger businesses and startups--which also means they're more prone to failure than venture capitalists. The latter are less likely to take risks on early-stage businesses and prefer companies that have already proven themselves.
Invested amount
As stated earlier, business angels typically operate either alone or in something called angel groups or networks. Their investments can fall anywhere between $20K and $500K -or more if several angels group together. Venture Capitalist will rarely offer less than $ 0.5m or $1m and often offer much more, which is perhaps too much for very early stage companies.
Role in your business
When investing, both groups obtain company shares. Nevertheless, venture capitalists habitually demand a seat on the board where business angels will more often take on the role of coach and advisor to the entrepreneurs running the business. As a rule, venture capitalists have more control over your enterprise than angel investors.
Due diligence
The topic of due diligence has caused quite a stir among angel investors through the years. Although some angels don't do much research– and they aren't really required to since it's all their own money – studies have shown that when angel investors commit at least 20 hours to due diligence, they're five times more likely to experience a positive return.
Given that they have a fiduciary responsibility to their limited partners, venture capitalists need to do more due diligence. When it comes to researching their investment prospects, venture capitalists can spend in excess of $50,000 and spend several weeks doing DD.
Similarities between angel investors and venture capitalist
Whenever you receive funding for your company from either venture capitalists or angel investors, you are sacrificing a portion of your ownership. It's crucial that you remember this fact because it comes with added responsibilities. Your investors' goal is to gain the highest return possible, and it falls on you as the manager to make sure this happens.
More than ‘just’ capital
Angels and venture capitalists don't only give you financial support for your business- they also have access to large networks which can help get your business off the ground. In addition, because of their previous experience with businesses- either through investing or running one themselves- they offer a bevy of advice and tips that can take your company far.
Venture Capitalist vs Angel Investor: Wich is better?
Every company, whether big or small, needs money to operate. That being said, for a startup it is crucial to have financial backing in order to stay afloat. The question then becomes: should startups consult with an angel investors or venture capitalist? Unfortunately, there isn't one right answer that fits all businesses; It differs based on what stage the company is currently in.
If you're looking for an investor and your company is in the early stages, a business angel is probably your best option. The amount they invest will be enough to keep you going at this stage, and because of the personal relationship you'll build with them, they can also act as a mentor.
After your business is established and you need more funding and/ or expertise to help it grow, a venture capitalist might be the right step.
How to pitch to angel investors
When you're pitching your startup to an angel investor, focus on aspects like your team and ideas rather than its immediate profitability. This can make them more interested in gambling on your company. Don't forget to include key business details too, such as the size of your market, what you're offering, who your competitors are and their weaknesses. If applicable, mention how much revenue you're already generating.
How to pitch to a venture capitalist
If you want to get investors and venture capitalists attention, explain the solution your company offers for a problem that many consumers have and how big of a market there is for it. Bring a business plan and pitch deck to your meeting.
The goal of your pitch meeting is to illustrate to the venture capitalist that, despite some immediate risks, their return-on-investment will be profitable in the long run. You'll do this by presenting a four-year projection of your company's income and expenses.
Conclusion: Angel Investors vs Venture Capitalists
When it comes to deciding whether an angel investor or venture capitalist is better for your business, the decision depends on what stage of development your company is in. Angel investors are a great option for early-stage businesses that need funding and mentorship. If you have an established company looking for more funds and expertise, venture capitalists might be the way to go. Both angel investors and venture capitalists can be a great resource for startups, but it's important to remember that you will have to give up some of your ownership in the process.
