Wrestling with an Angel Investor vs Venture Capitalist funding dilemma is a rite of passage for most start-up founders. So we’ve put together a special edition blog to help you decide which option is best for your business. We guide you through what Angel Investors and Venture Capitalists are, the benefits and drawbacks of each and which types and stages of start-ups can benefit most from these two types of investors.
What is an Angel Investor?
Angel Investors or Business Angels are typically wealthy individuals who invest their own money in budding businesses. Despite their seraphic moniker, Angel Investors expect a return on their investment. In exchange for capital, these benefactors seek a share of the business either as equity or convertible debt, for example, a simple agreement for future equity (SAFE) or convertible note.
How Angel Investors operate
Business Angels are often industry leaders who invest in early-stage start-ups that operate in their field of expertise or interest. If a nascent business catches their eye, they may bankroll it to anywhere between $10,000 and $500,000. As such, they tend to focus on helping early-stage or pre-launch businesses get off the ground, as their pockets aren’t deep enough to pick up the tab for a major scale-up operation. Angel Investors don’t have a controlling stake either as they typically receive a 10-30% equity share in the businesses they fund. As a rough rule of thumb, they look for an average annual return on their investment of 20-30% over three to eight years. Angels usually work alone, invest their own money and have independence, flexibility and agility when it comes to their investment choices and may even fund passion projects. These singular backers may provide mentorship, access to networks and other non-financial support to their padawan venture, but they don’t need to. Assistance from an Angel Investor is first and foremost financial.
Choirs of Angels
While Angel Investors usually operate independently, some work together in Angel Groups or syndicates. When Angel Investors flock together, their investment power increases to upwards of $750,000 per start-up, along with their potential to add value via mentorship to founding teams.
What is a Venture Capitalist?
Venture Capitalists (VCs) are businesses comprised of professional investors, who invest other people’s capital into businesses with significant potential to scale and deliver sizable returns. The capital VCs invest originates from individuals, pension funds, corporate bodies and even foundations. As VCs source capital from a range of organisations, the sums they invest are far higher than the amounts Angel Investors or even Angel Groups offer. VCs tend to get involved in multiple funding rounds that align with a start-up’s growth journey. These funding rounds are known as Series A, B and C. It’s not unusual for VCs to write a cheque for around $1 million as Series A funding for suitable start-ups. For later rounds, the sums invested are usually higher and in some instances can run to hundreds of millions of dollars, especially for a Series C capital raise.
How VCs operate
The first thing to know about VCs is that they are highly selective when it comes to investing in start-ups. So much so that under 1 per cent of businesses looking for venture capital end up actually landing any.¹ VCs want ventures that are highly likely to grow exponentially and deliver extraordinary returns for their fund’s investors. For that reason, they tend to target start-ups in extremely high-growth sectors, such as software and MedTech, that offer clever product solutions with large market demand. That means VCs don’t normally invest in very early-stage start-ups that are either pre-revenue or still fine-tuning their product/market fit. The second thing to know is the adage, ‘he who pays the piper calls the shots’ rings true when it comes to VCs. VCs take a controlling share of the businesses they fund. Once VCs back a business, they join its board and become actively involved in setting the strategic direction and hiring decisions to ensure the start-up is as successful as possible.
Angel Investors and VCs are similar yet different
You could be forgiven for thinking that there isn’t much to choose between Business Angels and Venture Capitalists. Both are looking for handsome returns on their investments and gravitate towards high growth businesses that have moved beyond the pre-revenue stage. And if your business and their investment don’t work out, you won’t have to repay either of them. But each type of investor has distinctive traits you should be aware of. This will help you decide which one is right for your business now and in the future.
- Are usually private individuals investing their own money in businesses that align with their interests
- Invest between $10,000 to $500,000 in early-stage start-ups
- Offer mentoring and access to networks as optional extras
- Are flexible and agile
- Don’t take a controlling share in your business
- Are patient and seek a return on their investment usually over three to eight years
- May provide mentorship, access to networks and other non-financial support
- Fund management businesses that make larger-scale investments in a small number of ventures
- Can invest between $1 million and hundreds of millions into businesses looking to scale up
- Have narrow investment selection criteria
- Might focus on investing in businesses in a specific scale-up stage, geographic location or industry sector
- Look for businesses that have products/services with a strong competitive advantage, highly capable management teams and significant market potential
- Take a controlling stake in the businesses they invest in and are actively involved in the running of the business and setting its strategic direction
- Offer advice, mentoring, and value-add services such as exit strategies as part of their investment package
Upsides and downsides
Let’s take a look at the pros and cons of Angel Investors and VCs for the different types and stages of start-ups.
Advantages of Angel Investors
- Early-stage start-up founders get funding and keep operational control of their business
- Angel funding is ideal for revenue-generating start-ups or if you’ve recently launched your product or service
- Successful or promising start-ups can receive funding quickly because Business Angels are independent, agile and often conduct more limited due diligence in comparison to VCs
Disadvantages of Angel Investors
- Angel funding alone is usually insufficient for businesses entering a major scale-up phase
- Angel Investors aren’t obliged to offer your business mentoring or access to their networks
Advantages of VCs
- VCs can bankroll your business with millions of dollars of capital to help it scale up and achieve its potential
- VCs are actively involved in your business to help it succeed
- VCs grant you access to their networks, advisory services and help with exit strategies
Disadvantages of VCs
- VCs take a controlling share of your business in exchange for their investment
- As a founder you can be ousted from your business if your performance falls short or you disagree with business decisions
- Selling the business or the founder exiting are common ways for VCs to realise their return on their investment
- VCs conduct extensive due diligence which means they are not a fast funding solution
Other funding solutions
What if your business isn’t ready for VC or Business Angel funding? If you are still at the pre-revenue or conceptual stage or don’t have the time or resources to court investors, then seed funding from family or friends could be a better option. Accessing traditional sources of finance such as bank loans is notoriously difficult for early-stage start-ups. And it has to be repaid with interest, whether your venture succeeds or not. If your start-up has R&D, then claiming the R&D tax incentive (R&DTI) and applying for R&D finance, for example, a Radium Advance is another possibility. A Radium Advance is a loan that grants you early access to money you’re going to receive from your R&D refund. It’s great for early-stage start-ups, but also for businesses with investors that want to avoid more dilution. So if you’re keen to explore your alternative finance options to bolster your R&D program, why not book a no-obligation call with one of our helpful R&D finance experts? Or you can find out how much you access using our calculator.
¹ Fundera by nerdwallet, 2020: Raising Capital for Startups: 8 Statistics That Will Surprise You. [online] available at: https://www.fundera.com/resources/startup-funding-statistics