Venture capital is private equity for startups or small businesses with solid growth potential. Angel investors are similar and provide capital to small businesses but use their net worth to provide investments. While seemingly identical, there are stark differences between the two types of investments. These tips will tell you to understand them.
Venture capital is private equity investors offer to startups or businesses that they believe have strong long-term growth potential. Angel investors are similar in focusing on small businesses but using their net worth to make investments.
Both venture capitalists and angel investors can help get businesses off the ground and seem similar in their approaches. However, there are critical differences between financing types. This article will outline what you need to know.
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“Venture capital is private equity for startups and businesses that are believed to have the potential to expand over time.”
Venture capital is most often provided in a monetary form. Still, it can also be technical or managerial expertise — anything that will help the business excel.
In venture capital deals, large portions of ownership in a company are created and sold to investors through limited partnerships established by venture capital firms. A limited partnership (LP) is when two or more partners go into business together but are only liable for their investment.
In an LP, there are limited and general partners. The limited partners are typically the investors, and the general partners are the ones who oversee and run the business that the limited partners invested in. This means the general partner has unlimited liability when it comes to things like business debt.
Compared to other types of private equity, like growth equity or buyouts, venture capital focuses most on emerging businesses seeking substantial funds for the first time. Other forms of private equity are more focused on larger, established companies.
Venture capital firms are also often industry-specific. This means one firm may specialize in investing in tech and has a team of investors who are also knowledgeable in the tech space. Healthcare, telecommunications, and industrial energy are other examples of industries that attract a lot of venture capital.
Venture capital can also be provided at other phases of a company’s lifecycle, including:
- Seed Capital
- Startup Capital
- Early-Stage Capital
- Expansion Capital
- Late-Stage Capital
- Bridge Financing
Seed capital is what you would be after if you were just starting out and didn’t have any products or even an organized company yet. The capital you receive could be used to create sample products, fund market research, or even cover administrative setup costs. At this phase, you don’t have any revenue streams, so you’ll be relying on venture capital to fund your operations.
Startup capital comes when you have a sample product and want to recruit more key management, conduct more market research, and prepare to introduce your product or service to the marketplace.
“You can use venture capital to increase productivity and ramp up sales and production, overall making your business more efficient.”
Early-stage capital comes in when you’re fairly established, maybe two to three years into your new venture.
When your business is well-established but still has room to grow, you can seek expansion capital to help get your business to its next level of growth. At this stage, extra funding can help you enter a new market or increase your marketing efforts in general.
Late-stage capital comes into play when your business achieves impressive sales and revenue. At this stage, you may be looking for capital to increase capacity, ramp up marketing, or increase your working capital.
Bridge financing bridges the gap for companies. It helps manage the time between when a company runs out of money and when it can expect to receive more funds. This type of capital is usually used to fulfill a short-term need or goal, like planning for an IPO or buyout.
Angel investors are wealthy, high-net-worth individuals who provide capital to startups or entrepreneurs in exchange for equity in the company. These funds can be one-time investments to help get a business off the ground, or they can be ongoing to support a company throughout its various stages.
Angel investors also don’t have to be strangers. Oftentimes, angel investors are the entrepreneur’s friends or family members. The investments can be risky, especially as they come during a startup’s early, volatile stages. However, these investments can yield much higher returns than traditional investment opportunities.
Angel investors also invest more in the entrepreneur themselves rather than the viability of the business. They want to help startups get their feet on solid ground and are less focused on the profits they can gain. This makes working with an angel investor a great option for startups.
Startups are hungry for cash, and angel investors have a lot of it to spare, but they aren’t predatory investors who are going to expect more from the business they’re investing in. Essentially, angel investors can help you graduate onto more advanced sources of funding, like venture capital, at later stages in your company’s life span.
There are many similarities between venture capital and angel investing. There are also significant variations regarding the characteristics of the investors, terms of their investments, and the types of businesses they give capital to.
When seeking capital, it’s important to know which financing source you should be pursuing based on your situation. Some of the key differences between venture capital and angel investors include:
- Source of Funds
- Investment Amount
- Involvement in Business
- Expected Return
- When They Invest
Angel investors are wealthy individuals, maybe even successful businesspeople, who are looking to invest their own funds into a new business. They’re not working with a pooled bank account or funding service. All the money they’re investing is their own. On the other hand:
“Venture capital investors work with venture capital firms that pool money from different groups of investors into one fund that is then invested into businesses.”
Because angel investors are investing their own money, it can be said that they take on more risks with their investments than venture capital investors do. If something goes wrong with an angel investor’s investment, they’ll be directly affected and lose money. Whereas with venture capital investments, if something goes wrong, it isn’t just one person taking a massive hit.
The amount that angel investors and venture capital investors are willing to invest is one of the biggest differences between the two. Because angel investors are individuals investing their own money, their investments are typically less than $1 million and average anywhere from $25,000 to $100,000.
However, since venture capital firms pool money from a number of investors and other sources like pensions and foundations, there is typically more money available to invest. Venture capital investments can start around the $3 to $5 million range and can go even higher than that.
For example, the average venture capital firm manages about $207 million each year for investors. A single venture capital fund has about $135 million in it, meaning there is a massive amount of money to work with.
Venture capitalists and angel investors are both going to want equity or control of business operations in exchange for their investment. However, they both go about it in different ways.
Angel investors may be very experienced in the business world and may be able to offer contacts to business owners. Other than that, they rarely want any direct involvement in running the business. They act more as mentors and may offer suggestions on how to improve operations, help you connect with lawyers and bankers, and even be sounding boards for decision-making.
Venture capital investors are the opposite. From helping with decision-making and general operations to requiring a seat on your Board of Directors, venture capital investors are extremely involved and aren’t really interested in acting as mentors.
Because venture capital firms are investing more money, they’re likely expecting a higher return on their investment. On average, venture capital firms may expect a return ranging anywhere from 25% to 35%. Angel investors are more focused on having faith in and building up the business owners rather than the business’s performance. Therefore, they expect a much smaller return, ranging anywhere from 20% to 25%.
The stage your company is at will greatly impact whether an angel investor or venture capital firm is the best fit. Angel investors prefer investing in startups. They typically choose businesses they’re interested in or ones that seem to have a lot of potential to become profitable, regardless of how early it may be in the business’s life cycle. This is where the added risk of being an angel investor comes in because these businesses are still very volatile.
“Venture capitalists go for established businesses or startups with strong, proven potential for long-term growth.”
Venture capital firms may also invest in startups if they’re backed by a well-known or already successful founder. Venture capital firms also help established businesses through important growth stages, providing capital to get them to the next level.
If you’re a business looking for venture capital, the first step is to submit a business plan to a venture capital firm. If they’re interested, the firm will perform what is called due diligence. This is essentially an in-depth investigation into the company’s business plan and model, products, management, operating history, and other important facets.
This extensive background research is extremely important because venture capitalists tend to invest larger amounts of money in fewer companies. To prevent losing money, they need to ensure their investments are sound and stable.
Once the due diligence is finished, the firm or specific investor will pledge a capital investment in exchange for equity in the company. Then the firm or investor begins taking an active role in the company and advises and monitors progress before releasing each round of funding.
After a certain period — typically four to six years after the initial investment — the investor will exit the company by initiating either a merger, acquisition or initial public offering (IPO).
In a lot of cases, angel investors likely already know the business owner. If possible, present your business plan to the angel investor you know. It may even be a more informal deal since you already have an established relationship.
Unfortunately, not everyone has an angel investor in their family tree or friend group. For example, you could be a veteran entrepreneur who gets discovered by an angel investor through old-fashioned networking at places. Check your local Chamber of Commerce, a Small Business Development Center, or even through lawyers or accountants.
If you’re specifically seeking out an angel investor, there are also online databases like the Angel Capital Association and AngelList, which gathers lists of angel investors that you can reach out to and pitch.
Venture capital is a form of private equity that investors provide to startups or small businesses that they believe have strong long-term growth potential. Angel investors are similar in that they focus on investing in small businesses but use their own net worth to make investments.
There are many similarities between venture capital and angel investing. Still, there are also significant differences between the two, and when seeking capital, it’s important to understand the differences to know which financing option you should be pursuing based on your business situation.
About The Author
Jonathan Hung is one of the most active angel investors in Southern California; his mission is to drive value creation within each portfolio company. In support of this mission, he serves as Co-Managing Partner at – Unicorn Venture Partners.
He and his team target investments in US companies with global market potential, focusing on long-term growth expansion to East Asian markets.
As a Managing Member for his family office fund, J Heart Ventures, Jonathan developed his investing prowess, making investments in startup companies such as Gyft, ChowNow, Miso Robotics, Clover Health, and Bitmain, to name a few startups he funded.
Jonathan has various degrees from the University of Southern California, the London School of Economics, the Massachusetts Institute of Technology, and The Wharton School at the University of Pennsylvania.