The Difference between Angel Investors vs. Venture Capitalists
All new companies require start-up funds to get their product to market or offer specific services to their designated customer. Those start-up funds can come from various resources such as owner investment, conventional business loans, capital from family and friends, angel investors, and venture capitalist firms.
It is often difficult for startups to get funds through conventional business loans for new products, software, etc. Those startups often look for investment from Angel Investors and Venture Capitalists.
There is often confusion between Angel Investors and Venture Capitalists. Angel Investors are sometimes referred to as Business Angels or Seed Investors. They are high net-worth individuals who have chosen to provide funds to new companies or young entrepreneurs in the early stages of the company’s development.
They are looking to invest in firms that can bring them outsized returns than they normally generate from safer investments. They focus on ascertaining the growth potential and ROI (return on investment) probabilities. They invest in start-ups in exchange for a fair stake in the fledgling company.
It is important to note that family members and friends can be Angel Investors. If so, legal contracts must be put in place for either interest in the venture or a payback plan. It is vital to be clear about the boundaries and responsibilities. Do it the right way and protect relationships.
Sometimes that investment is in the form of a lump-sum investment, or it can be a constant infusion of cash for the company as it goes through the initial startup phase. Angel Investors invest in the entrepreneur or founder of the company, not necessarily in the actual idea or the success potential of the business. There are three ways the funds are supplied by angel investors 1) a business loan, 2) convertible preferred stock, and 3) common stock.
Business angels actively participate in the businesses they invest in while some only provide the money. There are many angel investors who provide money to startups by way of crowdfunding. Crowdfunding has allowed fewer wealthy individuals to invest in new startups.
One of our students, Devin O’Neil has created a new product, the Magbelt, a magnetic belt. By the time he attended class, he had applied for a patent but did not know how to get it off the ground. During the class, he expanded his target market, refined his production costs, and determined his marketing message.
However, he faced a challenge that many inventors face-financing. Since this was a new unproven product, bank financing was not an option. At the time he was working for Lyft and was encouraged to discuss his new belt with passengers as he was driving them to their destination. He committed himself to doing so. A few weeks after discussing his new product with strangers, he met another young man who was extremely interested. Eventually, he partnered with this person and another individual and they initiated a Kickstarter campaign.
They were able to raise $583,544 with a Kickstarter Campaign and $604,601 with an Indiegogo campaign. His life was changed forever. Check out their campaign on Kickstarter.
Venture capitalists, on the other hand, are part of a large organization or a professional person, who uses funds of third parties to invest in new or rapidly growing ventures, by inserting capital into the firm.
· Third parties are investors in venture capital firms such as banks, financial institutions, insurance companies, pension funds, corporations, and high net worth individuals. They fund startup firms or small businesses that are not able to raise funds from normal funding channels.
· The startup company is promoted by young and qualified entrepreneurs, who do not have sufficient funds to turn their new idea into a reality.
In venture capital financing, the investment is made for a long term (3 years or more). Often, they buy equity shares of the company to get the right to participate in the company’s management and assist in its initial stages. Most venture capitalists expect to receive at least 25% of their investment.