STARTUP BASICS: ANGEL INVESTMENT VERSUS VENTURE CAPITAL
July 7, 2016
By Aaron Gard
At the Forrest Firm, we take on many clients looking to start new businesses based around products, services and proprietary technologies. As with any other subject, there are varying degrees of knowledge among our client base with regard to the relevant legal and finance terms they face when running a startup business.
So, it’s nice to get back to basics and remember that bright folks from all walks of life aren’t necessarily exposed to the terms that we use to help entrepreneurs and executives shape their companies every day. Today, let’s talk fundraising, specifically the differences between two very common forms of capital infusion: angel investment and venture capital.
Many startup founders turn to angel investment as a means of funding the growth of their companies. Angel investors put their own funds into play when investing in business, much as individuals purchase stocks or bonds on a larger scale in publicly-traded companies.
Angel investors play a key role in funding smaller enterprises in their earliest stages of growth. Angels can come from many places; they are typically wealthy individuals looking to diversify their investments or invest in businesses they can get their hands on and know first-hand. They can often be friends or family members of entrepreneurs, eager to see a loved one succeed.
We also see clusters of angels, taking the shape of investment clubs to seek startups for investment. Angel investors commonly share the thrill for entrepreneurship that propels and sustains many business founders. Many of them offer their advice and expertise to the business after getting involved financially, having often experienced the joys and challenges of entrepreneurships themselves in prior ventures.
When you’re looking to work with angel investors, know that each will make a decision based on his or her own criteria. The amount they are willing to invest can range from very small amounts to quite large, depending on the particular angel’s investment strategy. Some angel investors will bring more than cash to the table, and angels that have experience in your business’s industry can be especially helpful. Others take a more hands-off approach and invest in people they believe to have strong management skills.
Venture capital represents another level entirely in complexity and funding potential versus the world of angel investing. Rather than dealing with individuals or clusters of individuals, entrepreneurs enter a world of firms devoted to earning profits from infusing capital into early-stage businesses. Venture capital firms consist of professional investors managing funds sourced from all walks of life: public and private entities, corporations, pension funds and wealthy individuals and foundations.
At their core, venture capital firms are partnerships among those that run the investment fund (general partners) and their investors (limited partners). Unlike angel investors, venture capitalists don’t stop at due diligence and offering advice. In addition to taking an equity stake, venture capital firms typically demand board representation. Since their investments are usually much larger, in the millions of dollars, they take board positions and sometimes seek to bring pre-qualified people to officer positions within a company to ensure to the best of their ability that they receive an ample return on their initial investment.
Taking a management and ownership stake, however, doesn’t mean that venture capitalists want to manage startups through all stages of the business life cycle. Their goals are simple: help companies reach a point of sustained growth, divest their holdings and relinquish management controls, and receive a high rate of return on their initial investments.
Due to the size of their investments and the complexity of their involvements, venture capital firms typically wait later than many angels to invest their money. While angels are often interested in quite small, quite early-stage ideas, venture capitalists will generally want to see more traction (buzz word!) before making an investment decision.
Historically, there have been pretty clear lines between angel investors and venture capitalists. We’ve observed in recent years that the two groups have been moving toward each other. Rounds of angel investment are growing in size, while venture rounds are occurring earlier in the business life cycle. This closing of these gaps makes knowing your fundraising options, and the pros and cons as related to your business ambitions, more important than ever.
If you have questions about taking your business to the next level of performance, the attorneys of the Forrest Firm are here to help you navigate the world of capital fundraising. We will consult with you, providing education and advice on different options that will give the proper balance of growth and risk manageme