Angel investors differ significantly from venture capitalists in many ways, from investment size, stage, and criteria to their involvement in the company and exit strategy.
Investors are crucial for businesses. A startup can raise investment in different ways – seed funding, pre-seed funding, initial public offering (IPO), and Series A, B, C, D, and more.
If you have ever watched Shark Tank, a reality show on television, you might be familiar with these terms – “startups”, “investors”, “funding”, “equity”, and so on.
While angel investors fund their own money on startups, venture investors invest the money of the investment firm or company they work for.
Let’s discuss the differences between an angel investor and a venture capitalist so you can decide which is better for your startup.
Who Is an Angel Investor?
Angel investors are high net worth, very rich individuals, ex-entrepreneurs, or successful business people who often fund startups and early-stage businesses in exchange for some convertible debt or equity or ownership stake in their company. They are also known as Seed Investors or Business Angels.
By financing or funding them a significant sum of money, angel investors help startups grow their business. They invest in the early stages of a business to support their product or service development. Since risks are higher whether the investment will be profitable or not, angel investors set some investment limit, like 10% of the complete portfolio.
Many accredited angel investors meet at least one criterion established by the Security and Exchange Commission (SEC):
The angel investor must have at least $1 million of net worth regardless of their tax filing or marriage status.
Their annual income must be at least $200k in the last two years, and have a strong chance of maintaining that income or more in the future. This requirement becomes $300k if they file joint taxes with the spouse.
However, not every investor would be accredited and have met the above criteria. Some of them still become angel investors if they have high wealth, have better connections and experience in the industry, and can accommodate the risks associated with investing.
Angel investors are mainly of two types:
Active financers: These investors fund in small amounts but possess rich industry knowledge. They are an asset to a company they invest in and just advise in order to protect their equity and may be involved in the management.
Passive financers: They invest in companies with high chances of making a profit. They generally don’t like to be involved in the management and leave this to the entrepreneur.
Besides, if you are searching for funding, you can check the list of good investors in your area who can be angel syndicates or crowdfunding platforms. There are many cases when angel investors invest in a company whose owner or founder they personally know and trust. They can also be friends or family members.
Who Is a Venture Capitalist (VC)?
A venture capitalist (VC) is an investor belonging to a professional investment agency/firm or an investing firm (venture capital) who funds or provides “capital” to early-stage businesses and startups that show high potential in terms of growth and profits. Typically, they make more investments compared to that of angel investors.
Like angel investors, VCs also seek equity in the company they invest in in exchange for their funding. Some well-known venture capital firms are Sequoia Capital, Coinbase Ventures, Andreessen Horowitz, Kleiner Perkins, and Accel.
VCs often collect funds from third parties and invest in a growing company. Now, these third parties can be wealthy investors, banks, insurance providers, financial institutions, pension funds, etc. VCs can help new companies with their young, qualified entrepreneurs lacking sufficient funds to convert their ideas into reality.
Furthermore, VCs offer not only long-term funding but also help startups in developing their products and services, business networking, management expertise, ad and sales strategy, etc. They are one of the decision-makers in the company in order to help improve the operations, revenue, and profits.
Benefits of Angel investors for startups
The chances of getting funded are higher because they like investing in early-stage startups with good ideas.
No one holds them; they have their own money to invest freely wherever they want.
Borrower has fewer risks from angel investors. In many cases, they don’t take repayments if the startup fails.
They often have good business knowledge and might be an entrepreneur in the past or are currently a successful business owner.
They are well-connected in various industries.
Benefits of VC Funding for Startups
VCs offer a large investment money sufficient to support your ideas, products, and growth plans.
They may or may not require repayments on the failure of the startup.
VCs are experts in business so they can guide you.
You get a good networking opportunity in the industry you operate in.
Angel Investor vs. Venture Capitalist
Here are some differences between angel investors and venture capitalists on various grounds:
#1. Investment Criteria
Angel investors invest in a startup in its seed rounds. They also support the company in its next stages, like the scaling stage or Early Traction stage called Stage A. In order to make the investment decision, they typically follow this process:
Initial communication between the startup management and the investor via formal business meetings, referrals, seminars, etc.
Taking interviews with the founder to understand their business model, goals, current performance, development, and future growth potential.
Setting the investment terms, rights of the investor, and investor exit strategies.
Once everything is in place, angel investors can make their investment decisions.
On the other hand, VCs take time to understand every business detail of a company before they invest in it. They require the company’s management team to come up with a pitch that conveys their business models, ideas, performance, outcomes, and future growth.
Next, the VCs and the company seeking the funding negotiate with each other about the investment. If both parties decide to go further, a Memorandum of Understanding (MoU) will be set up between them.
The VCs also conduct thorough research about the industry, market growth rate, and competitor analysis. They estimate product life cycles, distribution channels, and market size. Once done, they need you to disclose full details of the company, like audit reports, investor veto rights, shareholder agreements, etc.
If everything goes well, they finally invest. However, VCs tend to be more strict when it comes to setting investment criteria. They also require startups to meet the defined targets and milestones.
Angel investors may or may not assist in the company’s management process and just acquire some equity to make profits.
On the other hand, venture capitalists fund startups and growing businesses by collecting funds from different sources. These sources can be hedge funds, pension funds, corporations, financial institutions, banks, or high-net-worth individuals.
In general, VCs become partners in a company they invest in and work closely with the founder in order to monitor and improve the business performance and enhance profits.
#3. Investment Stage
Angel investors fund a company when the business is at an early stage, lacking resources to develop its products and services. At this stage, the angel investor funds them so they can shape the business and its different aspects from the ground up.
In contrast, venture capitalists fund a later-stage startup that has started to show some revenue. The companies need to have a minimum capital base to operate and have the potential to grow in the future.
#4. Investment Size
Since angel investor funds a startup from their own net worth, they usually make a limited investment, lower than that of a VC. They typically fix a percentage such as 10 or 20 percent of the complete company portfolio.
According to the SEC, they must have at least $200,000 of individual income in the last two years or $1 million of net worth. So, the investment could be as low as a thousand dollars.
In many cases, the investment can vary between $25k to $100k more or less. If a group of angel investors comes together to fund a startup (Shark Tank has many such episodes for reference), the average investment could be $750,000 more or less.
On the other hand, VCs provide significantly more funding. They generate a lot of wealth from different sources to be able to invest in many startups. They can fund a single company with millions of dollars in order to support its business growth.
#5. Return Expectations
Since angel investors fund a startup from its early stage and take risks, they seek some percentage of ownership in the company based on the investment.
In contrast, venture capitalists don’t have a fixed ROI percentage. The return rate can increase with the company’s growth.
Angel investors mostly prefer minimal involvement in the company in terms of decision-making, operations, or management. In general, they don’t actively participate in the daily activities of a company. Even if they do, they do it strategically, not always operationally.
Venture capitalists, on the other hand, are involved in the management, decision-making, and daily activities of a business, both operationally and strategically. It’s because they expect greater revenue generation, profits, and growth.
#7. Funding Source
Angel investors have high net worth, so they invest their own money in potential startups that can generate good revenue.
VCs, on the other hand, gather funds from different sources like banks, wealthy individuals, financial institutions, corporations, funds, insurance firms, foundations, and more.
#8. Risk Appetite
Angel investors take on greater risks since they are investing in a company at its early stages when it would not have shown any significant success stories or revenue. So, it’s unclear whether the business will be successful or not, and the stakes are higher.
VCs, however, take fewer risks compared to angel investors since they invest in later-stage startups that have shown some revenue and have good potential to grow in the future. Thus, these companies are more likely to be successful in the future.
#9. Portfolio Diversification
Angel investors’ portfolio is typically diverse. They invest in startups belonging to different industries that are emerging and have the potential to register growth.
In contrast, venture capitalists have their portfolios more concentrated in a specific sector or industry. They generally invest in several startups but all belong to the same or similar industries. Their expertise in a specific industry helps them make fruitful investments.
#10. Exit Strategy
Investors can exit from a company if they don’t get the returns they expected or due to any other reason. This way, they no longer have to support it financially.
If an MoU and exit terms are stated clearly before investing, they can exit from the startup if their decision is valid as per the terms. Once they exit, they don’t have to continue investing in the business.
Generally, angel investors keep a longer horizon for their investment. They can withdraw the money via an acquisition, merger, or an initial public offering (IPO).
In contrast, VCs often are seen selling their invested money within five or seven years via an acquisition or IPO.
Angel investors have limited funds, so they invest less amount of money, which can restrict the growth of the business they support. In addition, they may lack due diligence. Many of them rely heavily on personal relationships and instincts without looking at the factual aspects, leading to losses.
Angel investors often make long-term commitments. This might lead to friction in the future and possible financial losses.
VCs, on the other hand, come on board with high expectations and standards for the business they invest in. They may require the company to achieve set goals and benchmarks in the short and long term.
In addition, VCs carefully perform background checks and interview founders to see whether the company meets the investment criteria before making any investment. They also keep realizing their investments in a given period and have a clear exit strategy.
These are individuals with a high net worth investing in early-stage startups and growing them in exchange for equity or ownership stake.
These are investment firms or professionals from an investment firm who invest in growing startups to obtain better returns.
Investment is less.
Investment is larger.
Use their own money to invest.
They source money from different organizations to invest.
Invest in early-stage startups.
Invest in later-stage startups.
Screening is based on personal expertise or instincts.
Through screening by experts.
Less involvement in operations and decision-making.
Active and strategic involvement in operations and decision-making
May or may not have an exit strategy.
Clear exit strategy
A diverse portfolio of investments.
Generally, they invest in a specific industry.
When Angel Investor Funding Is Better
Funding from an angel investor is better when:
You are just starting your business: Oftentimes, angel investors fund multiple companies knowing that not every one of them will be a profitable cause. They help grow a business from zero. So, if your idea and product are good, you might want to pitch an angel investor to invest in your startup.
You want more control: If you want to get funded and still have greater control over your business and decision-making, choosing angel investors is better. They are less likely to be involved in your operations and key decision-making and can just advise you with their expertise for growth.
When VC Funding Is Better
Funding from a VC is better when:
You are growing your business: If you lack more capital to grow your business and belong to a later-stage business, go for VCs. They will fund your company with some significant money so you can turn your innovative ideas into fully functional products.
You need assistance in management: VCs can help you with management, strategies, and operations.
You need more connections: VCs are partners with many financial institutions, foundations, and other organizations. So, your network, as well as your customer base, can increase more.
However, if you don’t like to go with either of them, you can consider crowdfunding as an alternative. It will help you raise funds from several individuals and support your idea and growth.
Angel investors and venture capitalists both invest money in startups to support their growth and make profits along with them. Although both are investors, there are many differences between them, as explained above.
So, if you are an early-stage startup, you may want to look for an angel investor. But if you want support for your ideas, develop your product, and grow your business more, you can look for a venture capitalist.
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