When you look at startup news, you see the terms “angel investor” and “venture capital” thrown around like Silicon Valley buzzwords. But entrepreneurs should consider them carefully. Depending on your startup, a little funding from an angel investor or VC firm could help you rapidly grow your business into a moneymaking machine.
So let's take a look at these startup-financing terms and find out what they mean for you.
What Is an Angel Investor?
An angel investor is an individual who provides their own money as startup capital for a new business. In return, the angel is usually compensated with ownership equity in the business.
“Generally speaking, angels tend to invest earlier in the company’s timeline and are often driven by the merits of an idea,” says
Terence Channon (@terencechannon),
managing director of
a company that helps early-stage businesses become more fundable for investors. “They will usually provide earlier stage dollars for a non-controlling stake.”
What makes them tick: Like other startup capital investors, angels tend to be interested in high-risk businesses that aim to disrupt a market and can grow quickly. They look for a clear exit strategy – such as a public offering or acquisition of the business – that will allow them to cash out with a high return.
But because they invest in whatever ideas they like and have no set limit for how little or how much they can invest, angels…
- Make up a broad group of investors.
- Fund a lot of different businesses.
“Angels can invest in a wider spectrum of businesses because it’s possible for us to make money on relatively small exits,” says
managing director of
Alliance of Angels
(@allianceangels), the largest angel group in the Pacific Northwest. “For the VC business model to work, they are restricted to deals that have the potential to deliver billion-dollar exits (which angels can and do invest in as well).”
“Unlike VCs, which are mostly in Silicon Valley, Boston, and New York City, angels are distributed across the United States. You can find groups of angels in most major US cities, everywhere from Bellingham, WA to Scottsdale, AZ.” – Yi-Jian Ngo, managing director of Alliance of Angels
What Is a Venture Capitalist?
Venture capitalists, or venture capitalist firms, manage other investors’ money. They tend to offer a lot more capital than individual angels, but usually at a higher price to the startup.
“Generally speaking, more established VCs (firms, in particular) will invest bigger dollars, require bigger stakes, demand more stipulations and terms (e.g., preferred shares or a board seat), and tend to be more actively involved than angels,” says Channon. He says VCs are most concerned with:
- A startups’ ability to scale.
- Customer acquisition results.
- The team leading a startup.
“How ‘good’ an idea is carries less weight for VCs than actual results to date,” says Channon.
What makes them tick: In return for the sizeable funding, venture capital firms will usually take much more control in directing the startup and require more ownership.
So what kinds of businesses opt for VC funding?
“The high-tech ones with an invention that can lead to disrupting a market,” says
George Alex Popescu,
editor in chief of the
and a partner at VC firm Lunacap Ventures (@Lunacapventures). He says the businesses that attract VCs are those that can offer inventions that result in a cheaper and better product, a clear value, and an easy path to commercialization.
Note, too, that your startup’s business structure affects if you can go after VC funding. Learn more in "It’s Okay to Go Solo: Choosing a Legal Structure for a Technology Startup."
Do Your Homework before Going after Investors
Want to court investors to fund your business idea? Great! But do your research first.
“VCs and angel investors are often industry-specific,” advises Channon. “You may have an awesome high-tech idea that could be the next Facebook, but if you are talking to a real estate investor, you’re likely going to get turned down.”
Here are some ideas to help you start your investor research:
- If you want to keep your business local, look for angel groups in your area that have an interest in promoting the local economy.
- Check out your network and see if you know any investors.
- See what other types of companies the investor has funded.
Lastly, think carefully about giving away ownership equity in your business. Is it worth the startup funds? Or are there other ways you can build your business? Remember the ins and outs of starting an IT business when you consider funding options.