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Who planted the seed, and why?
© Romolo Tavani/stock.adobe.com
Early-stage companies looking to raise capital to expand their operations may seek financial assistance from a specialized class of investors: The angel investor and/or the venture capitalist (VC).
If you follow the market—particularly that of start-ups and pre-IPO companies—you’ve probably heard both terms. And you generally know what they do—infuse capital into small businesses to help get them going. But do you know the difference between the two types of investors?
- How are their operations similar, and in what ways do they differ?
- Are there any types of business that one class of investor might prefer over another?
- What do angels and VCs expect to gain through their investments?
Key Points
- Angel investors and venture capitalists are known to fund new or early-stage business endeavors.
- Angels are more likely to be passive investors—friends or family—whereas venture capitalists typically work for professional firms.
- Venture capital firms are more likely to take an active role in managing a company, as well as a larger equity stake.
Maybe you’re an investor who’s interested in the early stages of capital formation, or perhaps you’re a business owner looking to raise capital from one of these two types of investors. Either way, here’s what you should know.
What is an angel investor?
An angel investor is (typically) a high-net-worth individual who invests personal funds into a start-up or early-stage business in exchange for an equity stake in the company.
This might be a wealthy friend or family member, or an affluent individual who knows your industry, likes your business ideas, and is eager to put cash into your endeavor for a stake in your company.
What is a venture capitalist?
A venture capitalist (VC) is an institutional investor employed by a risk capital firm that invests its funds into start-up or early-stage businesses in exchange for equity stakes in the companies.
It’s worth noting that venture capitalist firms are usually formed as limited partnerships (LPs), in which the roles and responsibilities of the management (general partner) are separate from the investors (limited partners).
What are the differences between angel investors and venture capitalists?
Although angel investors and venture capitalists both invest and raise capital, the differences between them can be quite pronounced.
For example, angel investors may help kick-start the companies that venture capitalists might scoop up at a later stage.
Angel investors may be eager to work with companies at the idea stage or the initial funding (i.e., ”seed”) stage, whereas venture capitalists want to see those ideas in practice. Why? Because the source of their funds and their operational processes, requirements, and goals differ. Let’s take a closer look.
Developmental stage: Angel investors may be willing to work at the “seed” stage; venture capitalists will want to see demonstrated potential for growth in a given market.
Funding source: Angel investors invest their own personal capital; venture capitalist firms typically invest other people’s money. VC firms typically package their investments into funds, which are placed with institutional and high-net-worth investors such as pensions, endowments, foundations, and large family trusts. Venture capital is part of the world of alternative assets, generally available to accredited investors.
Investment stake: Venture capital firms often have larger capital resources than most angel investors. Angel investments can start well below $1 million; venture capitalists tend to look for larger investments of at least the $3 million to $5 million range. The larger investment stake also means that VCs may demand a larger ownership stake (“equity percentage”) in the company. If and when a company matures, the VC will often look at an initial public offering (IPO) to shed (or at least diminish) its ownership stake.
Level of involvement: Although angel investors may have some experience in the industry in which the company operates, many may choose not to get directly involved in the business. In contrast, venture capitalists typically prefer a more hands-on role when it comes to operational decisions.
The bottom line
Both angel investors and venture capitalists play an important role in the early capital formation stages of a company. Not all the companies funded by these entities aspire to go public, but many do. If you’re an investor looking at an emerging business that’s just gone public, it helps to understand how the company got to that point financially. And if it did go the venture capital route, do a little homework and research on the VC firm and its history (i.e., success rate) for further insights into your targeted investment.
And if you happen to be a business owner yourself, you can decide which—if either—of these routes may be right for you. Alternatively, you might consider a small business loan or even an equity crowdfunding deal to help you grow and expand your business.
When you invest in yourself, you might find that others would like to invest in you as well.
References
- How the Changing Relationship Between Angels and VCs Can Work for Your Business | british-business-bank.co.uk
- The 5 Key Differences Between Angel and Venture Capital | gouchevlaw.com
- Angel Investors vs. Venture Capitalists | chase.com
