Many people get the idea to start their own business. However, these same people are unlikely to have sufficient cash on hand to launch the business. From real estate to marketing, employee wages to insurance, running a business requires a significant investment before a profit can be realized, requiring entrepreneurs to turn to angel investors and venture capitalists to secure the funding to help get the business off the ground.
Angel investors are an excellent option for entrepreneurs who need around $300,000 or less in funding and would like a mentor to help them give the business direction. Venture capitalists are better for businesses that need millions of dollars to take an already functioning business to the next level.
While like one another in the respect that both provide preliminary funding to businesses not yet capable of producing sufficient cash on their own, angel investors and venture capitalists differ from one another in many important ways. By understanding the specifics of what each provides, you can choose the funding source that best aligns with your business’ stage of development. Below are some questions you should ask yourself to get started.
How Much Funding Do You Need?
One of the most significant areas in which angel investors will differ from venture capitalists is in the amount of funding they provide a startup.
In most cases, angel investors will provide a startup with between $50,000 and $300,000 to get the business from the idea phase into actual development. While there are some cases when angel investors may provide more than $300,000, this will usually only occur when a group of angels get together to syndicate funds.
For the most part, though, angel investors are high net worth individuals interested in contributing up to six figures of funding for an extremely early stake in a business concept they like.
While similar, venture capitalists will provide significantly more money to a startup than will an angel investor. In most cases, businesses turning to venture capitalists will seek at least two million dollars, if not more.
Unlike angel investors, venture capitalists work together to pool their money together into a venture capital fund. There is likely to be one limited partner in the venture capital fund who is responsible for managing the capital and distributing it to businesses whom the fund thinks has outstanding prospects for growth.
What Stage is Your Business in?
Angel investors will often seek to invest their funds in businesses that are in their very earliest stages of infancy. This is why angel investors are sometimes referred to as “seed” investors—they invest their money in businesses that have yet to germinate into what they could ultimately become.
Sometimes, friends and family members will be referred to as angel investors because they are willing to contribute money to a loved one’s idea for a business. However, in the strictest sense, friends and family members are not actual angel investors unless they make a significant enough contribution equal to that of an angel investment. They must also be accredited by the Securities and Exchange Commission (SEC), used to describe investors with a net worth greater than one million dollars.
For an easy example of angel investors, think of the hit television show Shark Tank. In this program, startup ideas are presented to successful businesspeople who have already made their fortunes and are looking for additional investment opportunities. These wealthy businesspeople listen to pitches for businesses and ultimately contribute to those ideas that they think have the greatest chance of being successful.
In most cases, an angel investment is a one-time contribution to a startup that helps the business get off the ground. However, some businesses may be able to secure multiple rounds of angel investments.
Once again, venture capitalists are similar to angel investors in that they support young businesses trying to get off the ground. However, there are some subtle but important differences.
Venture capitalists will generally not be willing to fund a business that is still in the idea phase. Venture capitalists will want to see some framework of a successfully operating business already in place with an ability to produce revenue, with or without the additional funding.
Where venture capitalists really make their marks is in helping businesses explode in a young industry or into new and emerging markets. As such, venture capitalists will be highly interested in funding the following scenarios to help a business grow:
- Strong evidence of success in one market, with venture capital funds used to expand into another closely related market
- A business in an industry with unsatisfied demand, with venture capital funds used to help the business expedite production and beat the competition to market
- A revolutionary product or service that can use venture capital to optimize marketing efforts and help the business realize its market potential
Do You Need a Business Mentor?
The decision of choosing between an angel investor and venture capitalist can have a lot to do with what kind of mentorship the entrepreneur wants and needs.
While there are a handful of angel investors who will write a check to fund a startup and sit back and hope that it takes off, the vast majority of angel investors want to have some kind of mentorship role in the development of the business.
This can be anything from providing advice and coaching to detailed business plans for how to build the business from the ground up. Again, think about how Shark Tank investors counsel those entrepreneurs with whom they choose to work.
With venture capitalists, the range of possibilities is not so flexible. In exchange for providing the funding, the venture capital trust will want a place on the company board. This will help the venture capitalists ensure that their money is being appropriated in a satisfactory fashion.
While entrepreneurs will want to choose venture capitals with whom they share a vision, they must understand that they are giving up significant control of the company when venture capitalists come into play.
Venture capitalists are more than just mentors—if they become unhappy with the direction of the business, they can be instrumental in getting you voted out as CEO of your own company.
What Are the Investor’s Return Expectations?
One area that is remarkably similar between angel investors and venture capitalists is the rate of return they seek—and it is not small. In general, both angel investors and venture capitalists want to see a return of about ten times their initial investment over five years.
When the dust settles on this period, it can lead to these early investors having a roughly 30% ownership stake in the company.
The reason that the required rate of return is so high for these early investors is that most startups will ultimately go bankrupt, leaving the angel investor or venture capitalist with nothing to show for their initial investment.
Therefore, when they do hit, they want to hit big, balancing out all of that lost money to see their overall angel investment or venture capital portfolio yield a return over 20%.
When to Seek Angel Investors
For the most part, it is best to seek angel investors when your business is still in the idea phase. When you have saved and put every penny you have toward getting your business off the ground, but it is still not enough, then it could be a great time to start seeking angel investors.
Some things you may need angel investment funds to cover include:
- Financing to secure a facility for your business operations
- Equipment and/or technology necessary to manufacture a product
- Software licenses to make the business efficient and scalable
- A pool of money to have in reserve to cover operating expenses as the company works to become profitable
While it may seem like you could pay lower rates by taking out a loan from a bank to cover these business expenses, most banks are unwilling to finance small businesses for the required amount to get the business off the ground.
As such, while angel investors will take a hefty chunk when the business goes profitable, they are willing to risk everything on the chance that it goes bankrupt—something that most banks are unwilling to do.
How to Seek Angel Investors
It has been established that angel investors are generally wealthy businesspeople who are interested in increasing their investment portfolio by providing preliminary funding to startups that catch their attention.
Therefore, if you have a business idea or a business that is in its earliest infancy and need an angel investor to help you get it off the ground, consider the following pieces of advice to increase the chances that an angel investor will take a chance on you.
You may have the best business idea in the world, but if angel investors do not like, trust, and/or believe in YOU, then there is virtually no chance that they will fork over six figures to make your business dream a reality.
In the beginning, you may very well be the only piece of the business that the angel investor can see. Punctuality, professionalism, and personality are all great ways to earn an angel investor’s trust and ensure that he or she will take your funding requests seriously.
Network, Network, Network
As one of the world’s most high-profile billionaires (and one of Shark Tank’s famous sharks), Mark Cuban, likely gets bombarded with thousands of emails and messages a week from entrepreneurs begging him to “just take a minute and read my business’ executive summary.”
The same can be said for any other wealthy businessperson who is known to have an interest in angel investing.
The reality, though, is that close to all these requests get passed over without being given the least amount of consideration.
As the old saying goes, “it’s not what you know; it’s who you know.” Angel investors are far more likely to take a business pitch seriously when it is referred from a friend, past business associate, or fellow angel investor.
Therefore, really get a feel for the industry in which you plan to enter and do your best to get acquainted with the major players in your area. A robust coffee-time conversation may do more for securing funding for your business than the most elaborate business plan ever could.
Have a Firm Understanding of the Market
One of the fundamental tenets of business is that there is no business without customers. You can have the most outstanding business model in the world. Still, if your business does not address the needs of a specific customer base, then it is very unlikely to catch the attention of angel investors.
To secure angel investors, spend less time on product research and development and more time on market research and development. Angel investors do not think small and are highly unlikely to be interested in small markets and/or businesses that will capture a small share of a large market.
Pitch angel investors with concrete facts on the market your business will address and how much of that market your business can satisfy. There is unbelievable power in large numbers, so any business idea that is sure to appeal to many customers will surely get the dollar signs rolling in the minds of angel investors.
Show that Your Business is More than Just an Idea
While most angel investors are funding ideas and businesses in their earliest stages of development, there are more than a handful that are a little hesitant to fund an idea without something more concrete to back it up.
Therefore, any steps you can take to prove that your business is more than just an idea is sure to increase the traction of your pitch. Some ideas that may be appealing to angel investors include:
- Strategic partnerships that your business has planned with established firms
- Customer testimonials from beta-tested samples of products
- Discussions for early contracts or customers
- Product demonstrations
Profile of an Angel Investor
While it may seem like splitting hairs to distinguish between the sources of funding for a small business, several technical characteristics can help you identify a true angel investor, with the following list providing a solid breakdown:
- Funding comes from an individual person, generally of around $300,000
- The person must have a net worth of over $1 million (excluding personal residence) and/or have earned an income over $200,000 for the two previous years
- Uses his or her own money to help a business in its earliest stages
- Often used as the primary source of funding for startup businesses
- In addition to funding, the investor provides support and mentorship to the entrepreneur that fosters innovation and growth
- One of the riskiest investments possible, with angel investors willing to lose their entire investment
- Investors look to see a 10X gain of investment after five years to compensate for the high risk
- Will usually end up with about a 30% equity stake in the company
When to Seek Venture Capitalists
A business will be well past the idea phase when it approaches venture capitalists for additional funding.
Typically, businesses will already have a successful structure in place with the potential for enormous profits at the time they approach venture capitalists. They have already shown an ability to create revenue—or have a model in place that will support revenue growth—but lack the funding necessary to take their business to the next level.
Some ideas of when a small business may approach venture capitalists to expand its operations include:
- Moving into new markets, either geographically or with the introduction of a new product line
- A massive marketing campaign that is sure to put the business into the forefront of public consciousness
- Intensified production of hot products to beat the competition to the market and secure market share
Venture capital is commonly used to fund the growth of successful businesses that are still too small to incorporate and list public shares of stock. When a company is referred to as “privately funded,” there is a good chance that venture capitalists have provided a good chunk of its equity.
Well-known companies such as Facebook, Uber, and PayPal used venture capital to help fuel growth before incorporating and becoming publicly traded companies.
Note: One important point to mention is that some businesses will actually work with both angel investors and venture capitalists. Angel investors are the first round of investment, seed capital, to help launch their business idea. Once the company grows, secure venture capital to help them expand operations and reach a broader market.
How to Seek Venture Capitalists
If you have a more mature business that is needing some serious funding to expand operations—and, subsequently, profits—then it may be time for you to consider seeking some venture capital.
Venture capital tends to be a bit more challenging to obtain than angel investment. Due to investments running into the millions of dollars, venture capitalists are much less likely to stomach a company going bust than are angel investors.
As such, your business needs to be on solid footing with a strong track record and bright prospects for future success to be a candidate to receive venture capital.
If your business meets all these criteria, consider the following pieces of advice to help increase your chances of securing venture capital.
Know the Difference Between Angel Investment/Venture Capital
One of the quickest ways to turn off venture capitalists is by treating them or their funds like they are angel investors.
In technical terms, startups will typically undergo funding in several “rounds,” with the following a rough breakdown of how these rounds play out:
- Seed Money – This is the earliest funding that a building will seek that aims to get a business up and running in its initial stages.
- Series A Funding – This is a round of investment that is generally worth from several hundred thousand to the low millions that gets a young business to operating more efficiently.
- Series B, C, and Subsequent Rounds – These investment rounds are used to optimize and expand a successful business and can provide in the millions to hundreds of millions of dollars.
Venture capitalists will be focused on providing funding for Series B and later, so do not approach a venture capitalist in search of seed money.
Understand How Venture Capital Funds Make Money
Much like mutual funds, venture capital funds pool the money of many investors together and use this to back businesses they feel have a strong chance of success. As mentioned earlier, the portfolio of a venture capital fund aims to have a return above 20%. In addition, fund managers will typically be compensated in a manner commensurate with fund return.
By understanding how these funds make money, you can better illustrate how your business is uniquely positioned to grow, providing value to the fund in terms of the returns it gains and the compensation it yields for the manager.
Be at the Right Stage
Most businesses that are fortunate enough to succeed are ready for Series B funding after four years of operation. Therefore, this timeframe should be sought when approaching venture capitalists.
Pitching to venture capitalists ahead of four years exposes the fund to added risk, as younger businesses are more likely to go bankrupt. When the business is more than eight years old, it is nearly impossible to receive venture capital funding, as the growth upside has been reduced to nearly nothing.
Have the Correct Documentation
Unlike angel investors, who are likely to have never heard of the businesses they are being pitched, venture capitalists will indeed have some idea of what your business does, as it must be established before seeking venture capital.
As such, creative ideas and abstract ideas are likely to carry little weight with fund managers. True, they will want to hear about your vision for continued growth, but they are going to be more concerned with the hard data. Important pieces of documentation to include when pitching to a venture capitalist include:
- Executive Summary – One to two pages that capture the essence of your business and provides technical insight into your company’s unique position in the industry.
- Business Plan – This is a complete breakdown of the business’ history, your plans for growing the business in the future, all past financial data, how you plan to use investors’ money, and the return investors can expect to receive.
- Presentation Deck – A professional, visual representation of the information contained in the business plan should be used to enhance the pitch to the fund manager.
One important point to remember is that non-disclosure agreements should not be brought to a meeting with venture capitalists. These create legal headaches for venture capitalists that hear from a lot of businesses in a similar sector and can dissuade some investors from hearing your pitch.
In general, venture capitalists are not interested in stealing ideas, but, instead, hearing about how you can use their money to grow an idea.
Profile of a Venture Capitalist
Similar to angel investors, some unique technical characteristics can help define the funding received from venture capitalists, with the following list providing a breakdown:
- Pooled money from a wide array of investors who back firms with high growth potential in exchange for a place on the company’s board
- With investment amounts ranging from the low millions into the hundreds of millions, venture capitalists seek businesses that are known on a small scale and looking to go fully commercial
- Slightly less risky than angel investing, but still highly speculative, due to the large amounts of money being invested into companies that may or may not be ready for explosive growth
- Have a board position and influence to vote on company leadership
- Will be looking for massive returns, with a venture capital portfolio yielding over 20% the goal for most venture capitalists
When starting a business, the concept can be challenging to get off the ground without adequate funding. As most entrepreneurs do not have enough money in their savings and most banks are unwilling to offer loans to small businesses they see as likely to fail, you may have to seek outside funding to help your business reach its goals.
Two common means of funding to which many small businesses have been known to turn are angel investors and venture capitalists.
Angel investors provide money to businesses in their very earliest stages; this is usually personal money in the range of $300,000 or less that the business can use to help launch. In addition to the funding, angel investors will often serve as mentors to the entrepreneur and become a large equity holder if the company succeeds.
Venture capitalists are investors who pool their money together to create funds that invest in small businesses with an established track record that have the chance for explosive growth potential. This type of funding is provided to more mature businesses that are looking to go commercial and can range from the low millions up to hundreds of millions.
Both are considered risky investments, with a strong chance of losing the entire investment. However, when backing successful startups, both angel investors and venture capitalists can receive returns of over 10X.
When looking into these two funding options, it is essential to know your business’ stage of development, goals, and outlook to most successfully pair it with the most viable source.