There used to be a time when the difference between an angel investor and venture capitalist (VC) was more clear. But these days the lines can be blurred. With more companies seeking financing, and with more financing platforms to fund those companies, it’s sometimes hard to differentiate. You’ll hear terms like “seed investor,” “angel investor,” “accelerator,” or “venture capital firm.” But where does a “family office” or “crowdfunding platform” fit in? Are they angel investors or VCs? Or somewhere in-between? With so many funding sources in the ecosystem, it’s easy to get confused about your options.
Let’s clarify some of these terms and look at the key differences between the two main investor groups, angel investors and VCs, examine their differences and similarities, pros and cons, and then answer some of the common questions people ask about each.
What is an Angel Investor?
Traditionally, an angel investor was typically a high net worth individual who invested their own capital in the early stages of a business in exchange for ownership (or “equity”) in the business. Investors needed to be “accredited” and have millions of dollars to invest. These angel investors tended to keep a low profile and operated in closed networks. They would often either invest on their own, or in “syndicates”––alongside other high-net worth individuals they often knew or trusted. However, the Jumpstart Our Business Startup Act of 2012 encouraged alternative ways of funding small businesses, removed many investor restrictions, and paved the way for just about anybody to invest in a private company. The way angels operate is still essentially the same, but the wealth restrictions have been lowered when private companies work with investment platforms like Republic.
There used to be a time when entrepreneurs could raise angel investment off the back of a just idea, but with the surge in entrepreneurship and the sheer number of companies competing for investment, those days are long gone. That’s why you’ll hear the terms “seed funding” and “friends and family round.”
Seed funding tends to be loosely applied to that critical first stage of funding to get a business idea off the ground. It generally refers to the stage before an entrepreneur approaches an angel investor - when the business is just an idea and business risk is at its highest. That’s why entrepreneurs often seek funding from friends and family at this stage - people who trust and know the founder well enough to get the idea off the ground with their money and before entrepreneurs can approach angel investors who are generally strangers. But it’s not always so clear cut, and an angel investor can also provide the necessary seed funding depending on how much they believe in the business.
So what about “crowdfunding? If the restrictions on angel investing have been removed and you no longer need to be a high-net worth investor, isn’t crowdfunding a form of angel investing? Well, you might be forgiven for thinking that crowdfunding is a form of micro-angel investing. However, there are some well-defined legal limits on both crowdfunding and angel investor classifications, which we will look at in another article. But for the purposes of this article, the key difference is that angel investors commit large amounts of personal capital, time, knowledge, and connections to help the business get off the ground.
Today, an accredited angel investor is said to have at least a net worth of $1m which doesn't include the value of their home. You also meet the standard with a household annual income of $300,000 or individual annual income of $200,000. Investments tend to be between $25,000 and $500,000 (and sometimes even higher). As we’ll discuss later, these numbers are still much smaller than the typical investments venture capitalist firms make into a business.
Note: The final rule expands the "accredited investor" definition to include persons who maintain certain designations administered by the Financial Industry Regulatory Authority, Inc. ("FINRA").
Let’s revisit another term: “risk.” An angel investor’s capital flowing into the young business would be regarded as “risk capital” or “capital at risk.” Since the company is in its early growth stages, there is a greater chance of the business not working, since many aspects of the business are not yet proven (customer base, new market entry, acceptance of new technology, etc). An angel investor would consider the risk of losing their money to be higher in the early stages of business growth and would therefore seek a larger piece of equity in the business, relative to the equity stake a venture capital firm would take in the business further down the line when the business is well-established.
In addition, depending on the amount of funding an angel investor pledges to a startup, the angel investor may take a board role in order to have a say in how the company is run.
The level of equity in a startup all depends on the business valuation at the time the business issues shares, and is determined by a number of factors, but mostly by the perceived level of risk, the business success to date, history and experience of the founders, industry trends, and timing. On average, most angel investment deals fall in the ballpark of a 10% to 30% stake in the company for the first angel investment round, which is subject to dilution in later rounds.The potential to take such a large equity stake in a business is a key draw for many angel investors, especially if they’ve done their homework on the business.
It’s also not uncommon for businesses to have a follow-on round of angel investment. This is increasingly seen by angel investors as a prudent way to grow a company and control risk capital based on certain milestones being met. Angel investors often like to see entrepreneurs “bootstrapping” their business and many hold the view that too much cash too soon in a business can lead to an entrepreneur to make bad purchase decisions.
On the other hand, as an entrepreneur, this could also be a smart way for you to preserve equity. For example, instead of giving away 20% equity for $1 million in a single angel investment round, an entrepreneur could decide to issue 10% stock for $500,000 now, and then raise another $500,000 in a second angel round, but this time giving only 5% equity away. Why the 5% equity saving? Because you’ve been able to scale and validate the business with less funds, thereby reducing the relative investment risk, and increasing the value of the company (Note: We’ve simplified this example. Founders and investors should carefully evaluate decisions regarding company valuation and issue of shares.)
Today, technology has made it easy for many people to start a business, which has made the competition for startup capital high compared to a few years ago. Most angel investors would expect to see some evidence of proof such as product/market fit. If you’re an entrepreneur and haven’t yet demonstrated evidence of customer validation, and you’re still trying to prove the product or service, then your best route is “seed funding” via friends and family. Of course, there is some overlap, and you might still be lucky enough to find an angel investor to provide seed funding on the back of an idea, but be prepared to give away a higher amount of equity.
Who is a venture capitalist?
Unlike a business angel, which is typically an individual investing their own wealth in a business, a venture capitalist is an institution that has pooled a “fund” for the purpose of investing in businesses with strong growth potential. That fund can be invested in a particular sector, a particular geographic region, or at a particular stage of business growth. Similar to angel investing, the venture capitalist takes an equity stake in the business in return for capital flowing into the business.
The other key difference is that venture capital firms often invest in a business at a later stage of growth once the initial business concept has been proven and there is enough evidence of market traction.
One other important thing to note about VCs is the frequent reference to “Series A, B, and C”, which refers to the growth stage of the business seeking venture capital investment. In the past, a company would seek “Series A” venture capital investment to obtain“product/market fit.” However, with the increasing number of startups seeking investment, the venture capital industry has raised the bar even higher and the general trend needle is now pointing towards companies who have already achieved product/market fit and are now looking to scale. That said, the Series A rounds tend to be larger. Series B and C rounds tend to be for much greater “deal” sizes, where the company is now in rapid expansions stage and is most likely eyeing international markets.
Differences between angel investors and venture capitalists
As we’ve seen, business angels and VCs are both investors, but differ in their approach to investing. We'll be looking at some of their differences below.
1. Angel investors typically invest their personal funds and sometimes participate in the running of the business. On the other hand, venture capitalists are investing institutional funds.
2. Angel investors have smaller investment funds relative to venture capitalists, averaging anywhere between $10,000 to several hundred thousand dollars as part of a syndicate. On the other hand, the average venture capital investment can range from $1m in a Series A round to several hundred million dollars at the Series C stage.
3. Typically, angels invest in the early stages of a business and nurture/challenge/mentor the founder and team to find product-market fit. VCs for the most part avoid such early-stage risks and only provide the necessary growth and expansion capital for highly innovative, high-growth potential businesses with huge ability to scale globally. They look for companies with star teams and an advantage in a market big enough for exponential growth. One exception to this is the increasing role of startup accelerators, where VCs take an active role in promising young startups led by visionary founders and then “accelerate” their growth by lending their experience, expertise, and networks to the point at which they are venture-capital ready (be aware though that not all startup accelerators are run by venture capital firms).
4. Angels may decide to invest in a business based on a looser set of criteria, and the investment decision process may be much shorter. In comparison, VC funds generally have very narrow investment criteria and it may take some time before deciding whether or not to issue a term sheet.
5. Angels often don’t have the power to oust the founder. VCs do.
It’s a harsh reality that sometimes things don’t according to plan, and when that happens, investors need to do all they can to protect their money - even if it means replacing the founder. Although many angels may hold sizable stakes in a business, angel investors generally don’t have enough power to remove the founder. However, if you’re an entrepreneur seeking venture capital funding, you can rest assured that by this stage, you’ve probably lost your controlling stake in the business - which means that if the company doesn’t perform as well as you said it would in your business plan - well, anything can happen.
Similarities between angel investors and venture capitalists
1. Both investors put their capital to work in businesses they believe can succeed. They both hope to make return on investment at a 20% to 30% annual rate at the end of the day, with different levels of risk relative to the growth stage of the company.
2. Investors tend to invest in industries they're familiar with in order to increase the chances of picking good companies. It's logical: you do better if you know what you're doing.
3. Both angels and venture capitalists exchange capital for equity in the companies they invest in.
Pros and Cons of working with a venture capitalist
If you’re a founder who has succeeded in raising VC funding, then not only are you guaranteed larger amounts of funds to achieve rapid growth, but you’ll also benefit from industry insights, mentoring, support, and connections.
VCs are starting to offer other value-added services in addition to “just” the funding, providing additional layers of support along the way. If the partners in a VC firm have previous experience in growing and exiting companies, that can often be as valuable to the entrepreneur as the funding itself
For an entrepreneur, taking capital from a venture capitalist means relinquishing substantial ownership of their pet project, especially if the founder has already raised a number of previous friends and family and angel rounds. By the time the company has reached Series A or B, the founder may end up with little control of their company and can even be ousted by the board. Steve Jobs of Apple, Dov Charney of American Apparel and Andrew Mason of Groupon come to mind.
Pros and Cons of Working with an angel investor
As we said earlier, any angel investment is regarded as “capital at risk.” Experienced angel investors are generally more willing to take chances with early-stage businesses and entrepreneurs as they have already factored this into their investment strategy as a high-risk investment and know they might not get their money back. If a company is at the final stages of product development and looking at a successful market launch, then an experienced angel could also serve useful to nudge and nurture the founder and team until they achieve product-market fit. For an entrepreneur, this type of experienced investor can be a godsend.
For many entrepreneurs, angel funding is also a better option than taking out a loan to grow a business. Loans can look enticing because lenders don't want equity in the company, stay away from operations and aren’t seen as meddling in the running of the company decision making. But loans may not be the best path for a founder and early-stage business, since the money has to be repaid, and early-stage businesses generally do not have the cash to make such repayments. Loans generally don’t come with outside expertise or contacts, or the willingness of the person putting in the money to roll up their sleeves and help the company grow - all things that an angel investor can bring to the table. And, since these factors greatly increase the chances of success, angel funding always may be a better deal - especially if the company ends up not performing and there’s no loan to repay.
Unlike a VC who invests institutional funds, as an angel investor you’re putting your own money on the line. For some angel investors, this can end up being an emotional roller-coaster, especially if the company you invested in doesn’t perform as well. Although angel investors may have certain voting rights when it comes to certain decisions being made at the company, angel investors generally don’t have enough of an equity stake in the business to force the founder out if the company doesn’t perform well.
So as an investor, if you hope to protect your capital and bring in any form of returns, you’ll need to think of spreading your angel investment risk across a portfolio so that, similar to VCs, the potential losses in the poor-performing startups can be offset by the potentially huge gains in the most promising startups. But if you have the industry experience as well as the cash, you have the opportunity to invest your time, skills, expertise and networks to make the venture work.
Why you should start with Republic
Republic is an investment platform that allows you to quickly develop the expertise, insights, and confidence for becoming an experienced angel investor. At Republic, we've carried out strict due diligence and even put our own funds into the many of the companies you’ll see on our website and since we’re active backers in many of them, we strongly suggest you take a look at them too. After all, we’re here to keep you away from those companies we don't believe are going to succeed.
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In this guide, we brought the roles of an angel investor and venture capitalist to light by looking at
Who is an angel investor and a venture capitalist?
What are the differences between an angel investor and a venture capitalist?
What are the similarities between an angel investor and venture capitalist?
Pros and Cons of working as/with each of these investors.
And 3 frequently asked questions about an angel investor and venture capitalist.
Now, whether you are an entrepreneur or investor, you have a pretty solid idea of what these investors do and can take appropriate action to grow your business and develop your career respectively. If you can't become a venture capitalist or angel investor, you don't have to miss out on the upside of investing in businesses. Republic has done the hard work for you. You just have to select the companies you care about and invest.
This educational article is provided by Republic to help its users understand this area of the market, it should not be construed as investment advice as it is impersonal, disinterested and was produced by Republic for Republic’s users, without remuneration received or expected.
Angel investors vs venture capitalists