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Angel Investors vs. Venture Capitalists: Who Should You Go For?
Do you have a multi-billion business idea that you think will change the world? Or a business proposal that's sure to make you a millionaire. Everyone experiences that sometimes. The only problem is that not all of us can fund that idea and start the business. It's understandable since funding your business is one of the most complex parts of starting it.
If you’ve done your research, then you must have heard of angel investors and venture capitalists. But what’s the difference between both? If you’re wondering about the answer to this question, then you’re not alone.
It’s quite a standard question, you see. Sometimes, people even believe that they’re the same. While there are undoubtedly similar aspects between the two, how they work are different.
What is an angel investor?
An angel investor, also known as a seed investor or private investor, is a high-net-worth individual looking for business ideas or people to fund their startups. This is in exchange for equity in the business.
Often, angel investors can be friends, family members, or someone you just met recently. No matter who it is, they provide you with a one-time investment to help your startup take off the ground or give more additional funding to help your business expand.
These kinds of investments are risky for an angel investor, so it only makes up for 10% of their portfolio. That said, most angel investors only offer their excess funds to financially back someone with a chance of a high investment return.
Angel investors typically offer their own money rather than pooling with other investors and offering them to companies. Although angel investors are usually high-net-worth individuals, they also often come in the form of a limited liability company or LLC, a trust fund, another business, or an investment fund.
Some angel investors even fund their beneficiaries through a crowdfunding event on online platforms or find other angel investors and pool their money to fund your business, much like venture capitalists but without the pressure.
The effective internal rate of return for an angel investor’s profile is 22%. If you think about it, it might be too steep for a startup, but this is usually the standard. Also, that cheaper sources of financing, such as lenders and banks, are usually not available leaves you no choice.
Although the rate of return is steep, angel investors are still the perfect choice for entrepreneurs struggling to find money to start their businesses.
Just like any source of funding, such as quick cash loans, angel investors are ideal for your business. However, it’s no easy feat to find them. It requires a lot of work and effort on your part.
This is because they usually invest in the entrepreneur themselves rather than their business. They are more focused on helping startups take their flight than the possible profit they will have in the future. This is what makes them different from venture capitalists.
What is venture capital?
Venture capital is a type of private equity investing where investors fund small startups to promise profit in the future. Of course, since we are talking equity, these funds are exchanged with a portion of the equity in the business.
While angel investors help startups take their first steps, venture capitalists will enter the scene and offer funding to help the company expand further when that company starts making a profit.
However, as the company’s revenue goes stronger and the margins widen, venture capitalists will leave to make way for private equity investors. Venture capitalists are just as important as angel investors.
This is because unproven business concepts typically have a hard time getting traditional funding. After all, conventional funding sources often require a business to have evidence in business profitability, a track record, and collateral.
When a business is struggling to find funding sources to expand, venture capitalists can provide.
So, who should you go for?
Instead of picking between the two, why not both? What you can do is to look at the investment stages of the business these people go into. As mentioned earlier, when you’re just starting your business, the best funding source other than the traditional funding sources is an angel investor.
They look more at the entrepreneur rather than the business, and they help startups take off. When your business starts growing its revenue and is looking to expand, you can ask for funding from venture capitalists.
Most angel investment deals aren’t loans. And the best thing about them is that when your business goes flat, they usually don’t require their money back (although it might hurt your reputation). This is helpful to know since it puts pressure on your investor to do their due diligence in your company. However, it just makes it riskier for them.
On the other hand, venture capitalists are more aggressive. That’s why they tend to require more results immediately, giving you more pressure as you work. This can also lead to a lot of major decisions. Of course, this doesn’t mean you’ll lose your company, but their voices will certainly be heard. After all, they are managing your money.
That said, look at your company's growth potential. For example, suppose your business is only about dental practices, and you aren’t planning to change that in the future. In that case, you'll have limited exit strategies, and one of them is selling the company to a larger market. If all else fails, your investors will sell their stocks to other investors willing to take the risk.
Depending on where you are in your business plan, whether you’re still in the concept-making stage or have already established a company, finding the right investor is crucial to keep your business running. When they hear about the responsibilities, many people tend to be scared and decline any funding. But don’t let that happen to you. Taking risks is the first step to being successful.
This article does not necessarily reflect the opinions of the editors or the management of EconoTimes