post by:
Michael Goldstein
There are multiple ways you could look to secure funding for your business. It could be as simple as asking friends or family to help fund your plans but, if you need a substantial amount of financial support, other more official funding options might be your only choice.
Two possible ways of raising money for your business are through an angel investor or a venture capitalist. Understanding the difference between these two funding options is important if you want to make the right decision for you and your business about which one to seek funding from.
What Is An Angel Investor?
An angel investor is an individual (usually) who has a high net worth. They tend to have a net worth of more than $1 million or an income of at least $200 000 per year. Having access to this amount of money puts these people in a strong position to invest in businesses they think could be successful.
Angel investors invest in new or small businesses that have the potential to make a lot of money. In return for their investment, the angel investor receives equity in the business. This tends to work well for everyone involved as the business doesn’t need to worry about making repayments on the investment, and the investor makes their money back and then some the more successful the business becomes.
As a general rule (although this isn’t always the case), angel investors will have some level of experience in the type of business they are investing in. For example, an angel investor with a background in retail might decide to invest in a fashion startup but they might decide against investing in a technology-based business. This makes sense when you consider that the angel investor will likely only get any return on their investment if the business they are backing is successful. If they invest in a business that they could actually help guide towards success, they have a greater chance of making more money.
Angel investors usually invest a relatively small amount of money compared to other financing options out there. The average angel investment is typically somewhere between $15 000 and $250 000 although more or less could be invested depending on the business requiring investment and the financial commitment willing to be taken on by the investor. Despite these smaller amounts being invested, angel investors put more than $25 billion into businesses each year.
In return for their financial support, angel investors will receive equity in the business they are investing in. They usually ask for somewhere around 20% to 25% of the business but this can vary quite significantly depending on the amount of investment they are providing and how successful they think your business could be.
Something to keep in mind with angel investors is that, as they are usually individuals, they may take on a pretty active role in your business. This could be as simple as them offering you advice and guidance but it could also be where they want a seat on the board (if your business has one), they might want to manage projects along side you, or they may want to take control of certain aspects of your business. Only you can decide if their investment is worth giving up not only equity in your business, but potentially giving up some operational control too.
Angel investors could be suitable for your business if you are a new company and you are only looking for a relatively small amount of capital. As long as you’re willing to give up equity in your business (and potentially some control), finding an angel investor could be exactly what you need to move your business forwards on the road to success.
What Is A Venture Capitalist?
Venture capitalists usually are part of a venture capital firm that has access to a large pool of money that can be used to invest in businesses they deem to be worthy of investment and likely to succeed in a big way. The amount of money actually available for investment varies from one venture capitalist to another, but it would probably be fair to say that having several million dollars available at any one time wouldn’t be surprising.
As venture capitalists have a lot of money to play with, they tend to have a lot more scope for the types of businesses that they invest in. That being said, despite the large quantities of money available, venture capitalists only usually invest in companies that they believe can offer them high returns. As a general rule, a venture capitalist would likely expect a return of at least 25% to 35% throughout the lifetime of their investment.
In some ways, it could be said that it’s harder to gain investment from a venture capitalist than it is from other financing options. This is partly because they tend to focus their investments on companies within industries they feel are in a strong position. For example, in just 3 months, venture capitalists invested more than $25 million into the internet industry. The second largest industry to receive investment from venture capitalists during the same time period were companies within the health sector followed by businesses operating in the mobile and telecommunications industry. All of these industries are likely to stay relevant and financially viable for a long time so it makes sense why they are seeing such high levels of investment.
Typical venture capital investments can easily get into millions of dollars which can obviously be extremely beneficial for your business. However, the flip side to this is that venture capitalists may want somewhere between 25% and 50% equity in your business depending on how risky they see their investment being. The greater risk their investment is thought to have, the more equity they will want to counteract and balance the risk.
One of the key things to think about when looking at working with a venture capitalist to secure funding for your business is that they usually become very involved in your business. This could be a very good thing as the network of people involved in venture capital firms tend to have a huge wealth of business and industry-specific knowledge that could grow your business quickly. However, as venture capitalists invest so much more money into your business, they can easily find themselves in a controlling position. Effectively, this means that you might not be the most influential person in your company and you could lose a lot of your decision-making power. If you feel your business is in a position where giving up some control might not be an issue for you, then venture capital funding could be a good choice for you.
The Differences Between An Angel Investor And A Venture Capitalist
Although both angel investors and venture capitalists invest money into your business, they are actually very different things. It’s extremely important that you understand the key differences between them to maximize the likelihood of not only securing investment for your business, but also to make sure your decision has the best long-term interests of your business in mind.
Angel Investors Are Individuals, Venture Capitalists Are Part Of A Firm
Angel investors are usually individuals who are investing their own money into your company. As it’s their personal money at risk, they will obviously want equity in return, but they will also likely want to be involved in your business in some way. This could be as an advisor or they might want to take on a more operational role to help increase the chance of getting a good return on their investment.
Venture capitalists work as part of a firm and invest money from a collective pool of capital. They are professional investors who make their money from investing in businesses. They tend to have a less personal approach and usually take a larger percentage of equity from your business.
The Size Of Investment Is Different
As angel investors are individuals, they won’t have access to as much money as venture capitalists who work as part of a firm. Angel investment will usually be no more than $250 000 although much smaller and some larger angel investments are possible. Ultimately, it will depend on how much money the angel investor has to give and how much risk they are willing to place on investing in your business.
Venture capitalists have a huge amount of money to invest in businesses. With investments of around $7 million (and more) very possible, they can offer huge sums of money to growing businesses. This dramatic difference in the size of investment does lead to a greater increase in equity required too though which is something to keep in mind.
Motivation And Goals Can Be Very Different
Angel investors mainly offer financial support and nothing else. That’s not to say that they won’t want to get involved in your business in some way, but there will be some who simply invest their money and then sit back and let you carry on running the business as you wish. As angel investors are individuals, you can come up with an arrangement that works for both of you and your business with lots of flexibility. It could be that after their investment, you just want to ask for advice or use their network of contacts to help you move your business forward. Depending on the arrangement you made with your angel investor, they may or may not play a significant role in your business.
Venture capitalists definitely play a big part in your business after they have invested. They go through a long and thorough process to make sure your business is suitable for them to invest in but they don’t just stop there. Once a venture capitalist has invested in your business, it becomes their goal to do all they can to make sure your business succeeds and makes them money. They might get involved in the recruitment of senior management and they may even help develop the strategic focus of your business. Their goal is for your business to be as successful as possible so they can be extremely helpful in growing and developing it.
Investments Usually Happen At Different Stages
Usually, angel investors only invest in startups or early-stage businesses. This is when having additional financial support can make a huge difference to a business and can actually be the deciding factor as to whether it succeeds or fails.
Venture capitalists usually invest in established businesses with a proven track record of working in a way that is likely to see them reach high levels of success. That being said, venture capitalists can and will invest in startups too if they are showing signs that they have what it takes to be successful in their industry.
Startups usually require less investment to get things moving so angel investment can be a good match. More established businesses that are looking to grow will commonly need a lot more capital to do so which is where venture capitalists can be particularly useful.
Pre-Investment Due Diligence Is Very Different
An angel investor will be investing their own personal money into a business of their choice. If their decision to invest results in them losing their money, no one else will be losing out other than the angel investor themselves. Some angel investors will do pretty much no due diligence at all before investing. This tends to be when they know the owner of the business they are investing in and trust them enough to make good decisions. However, some angel investors will do due diligence to make sure they are making the right decision in investing in a business.
Venture capitalists will do a lot of due diligence before making a decision whether to invest in a business or not. This is because they have a responsibility to the firm they work for and to the partners who have contributed to the pool of money that will be used for the investment. The due diligence process can take a long time if you are seeking investment from a venture capitalist. The money at risk does not belong to any one person so risking it is not an option.
Pros Of An Angel Investor
There are some benefits that can be experienced when working with an angel investor.
Simple Pitching Process
The first pro of angel investors is that the pitching process is a lot easier than it is if you’re seeking investment from a venture capitalist. As the angel investor is using their own money to invest, you only have to convince them you have what it takes to succeed in your business. They will be more interested in your background, your passion, and your ideas than looking at the past performance of your business.
Investment Is Based On Trust Not Data
Another very beneficial thing about angel investment is that it tends to be based on trust and character rather than data and sales figures. This is particularly useful for startups that probably don’t have a whole load of information available about the business performance. Instead, the angel investor will base their decision to invest largely on the level of trust and confidence they have in the business owner.
Personal Relationships Can Be Built
As angel investors are individuals, you can actually build strong personal relationships with them. This can be a very useful thing to do as, if you communicate with them regularly, they may feel more obliged to help you out in some elements of your business operations. It can be surprising how much impact an extra piece of knowledge or an extra contact in your network can have on the success of your business. Angel investors are usually successful business people themselves so building strong personal relationships with them can certainly help you achieve similar levels of success.
Speed Of Investment Is Usually Quicker
With less due diligence and only one person making the decision whether to invest or not, getting funding from an angel investor can be a much quicker process than other funding options. As the amount of money being invested is usually smaller too, this tends to make it quicker and easier for an investor to access the funds and send them your way. There will obviously still be processes that need to be completed but, as a general rule, angel investments take less time to complete than other funding options.
They Could Become Repeat Investors
If you build a good relationship with your angel investor and they see good returns from their investment, there’s definitely a possibility that they may choose to invest in your business again in the future. Having someone who believes in your ability to run a successful business can make a huge difference when you try and grow it in the future. If you perform well with the help of an angel investor, they could very well be part of your long-term business success.
Cons Of Angel Investment
There are also some downsides to angel investment. These need to be considered and thought about in detail before deciding if angel investment is right for you and your business.
Fewer Funds Available
Usually, angel investors will not be able to offer as much financial support as other financial options (like venture capitalists). With common angel investments being somewhere between $15 000 and $100 000, it might not be the best choice for your business if you need a substantial capital boost to move your business forwards. While larger (and smaller) angel investments are possible, they do tend to be on the smaller side of things.
More Equity Lost For High-Risk Investments
An angel investor might want a lot more equity in your business than you’re willing to give. This tends to be the case when an investment is considered to be a high-risk investment. If your business has the potential to succeed but it’s by no means guaranteed, more equity will likely have to be given to an investor for the deal to go ahead.
Pros Of A Venture Capitalist
Like angel investors, venture capitalists come with some interesting perks that can make a difference when deciding what the best investment option for you is.
Substantial Investment Is Possible
Venture capitalists have access to a lot of money. Investments of several million dollars are common and can make a huge difference to your business. If you need a substantial cash injection, venture capitalists could be a great choice of investor.
Greater Network Of Useful Business Contacts
Perhaps one of the biggest advantages of venture capitalists is that they open the door to a whole network of contacts who could help you and your business to succeed. Not only will you have access to the professional investors and the business people involved with the venture capital firm, but you’ll also have access to the network of other businesses that the investors are involved with too. This can make a huge difference to your business as more advice, support, and partnerships could come as a result of the investment.
Larger Investment Opportunities In The Future
If the initial investment made in your business proves to be a successful one, this opens up the door for even larger investments in the future. This gives you a lot of room for potential growth and your business could end up much bigger than you ever imagined it to be.
Cons Of A Venture Capitalist
There are some downsides to venture capitalists too that also need to be considered.
A Harder Pitch Process
Pitching your business to a venture capitalist will be a lot more challenging than it would if you were pitching to an angel investor. They will want to know a lot more about your business and will expect to see some detailed data about how well your business is performing. If you are unable to show them what they need to see, the investment will be unlikely to happen.
Longer Investment Process
The time it takes to go through the entire process of reaching out to a venture capitalist, due diligence, and the actual funds making their way to you can be long. If you need funding quickly, a venture capitalist might not be the best choice for you.
Which Type Of Investor Is Best For Your E-Commerce Business?
Deciding whether an angel investor or a venture capitalist is the right type of investor for your e-commerce business will likely come down to a few factors. The first thing to think about is the stage at which your business is currently at. For example, if you’re just starting out and have very little in the way of reporting and data to back up the performance of your business, an angel investor will probably be the only one who can help you out financially. However, if you are running an established e-commerce business and can prove it has been performing very well, a venture capitalist could be interested.
You also need to think about how much investment you need. If you need anything more than $200 000, an angel investor probably won’t be able to help you. As venture capitalists have much more money available to them, they might be in a position to offer you several million dollars if your business is deemed suitable.
An important aspect of investment that needs lots of attention is the amount of equity and control you’ll be expected to give up in return for the investment. An angel investor might be happy to give you the money you need and let you get on with things on your own, but a venture capitalist won’t be. They will be heavily involved in your business and will usually take a much bigger equity stake too. Any equity given up needs to be carefully considered as you could end up not being the biggest decision maker in your own business.
Ultimately, an angel investor or a venture capitalist could be a good match for your e-commerce business. Venture capitalists are investing heavily in internet-based businesses so there is a lot of money available for companies that have the potential to make an impact throughout the industry. Angel investors can offer you the money you need quickly and with less hassle so they too could help you and your e-commerce business achieve success.