Funding is a crucial aspect of developing a startup. Startup founders typically begin funding from their own resources initially but eventually seek additional funding from venture capital or angel investors.
Venture capital and angel investors have their own differences that founders need to consider before deciding on funding sources. Some fundamental differences include characteristics of investors and investment terms.
To better understand the distinctions between venture capital and angel investors, let’s explore these differences in detail.
Venture Capital Definition
Venture capital is a company created to provide investment funds to small companies, especially startups focused on technology and rapid growth. In exchange for the investment provided, venture capital acquires partial ownership of the recipient companies. The goal is to achieve greater profits than the initial investment when these shares are traded in the future.
Venture capital raises funds from limited partners (LP) or investors, and no funds are received without an expectation of returns. LPs can come from various entities, such as investment firms, pension fund managers, or even conglomerates.
Angel Investor Definition
An angel investor is a wealthy individual who provides financial support to small companies like startups and often requests ownership stakes in return. Usually, they are close associates such as family or friends of the entrepreneur. Referred to as business angels, angel investors provide a one-time investment to startups to help them through challenging development phases.
They are more focused on assisting startups rather than seeking substantial profits. Although the risk is high, the returns from their investments are enticing.
There are various types of angel investors, including family and close friends, affluent individuals, and groups/networks.
Differences between Venture Capital and Angel Investor
1. Ownership of Funds
Venture capital is an entity in the form of a firm or company, collecting funds from a group of investors and investing them in potentially high-growth startups. On the other hand, angel investors are predominantly individuals, often wealthy business people or entrepreneurs. Angel investors generally avoid significant investment risks as they use personal funds, whereas venture capital has a broader scope to invest in low- to high-risk companies.
2. Investment Stage
Venture capital typically selects companies that already have a reputation and a track record of success. Some venture capital firms may even choose companies backed by notable figures. In contrast, angel investors usually appear in the early stages of startup development, such as during market research or product development.
3. Investment Amount
In terms of the investment amount, venture capital operates with more substantial funding, targeting larger investments. Startups often receive injections of at least USD 3 million or more from venture capital. Conversely, angel investors mainly invest below USD 1 million, sometimes ranging from USD 25,000 to USD 100,000.
4. Preferred Company Types
Venture capital and angel investors exhibit different preferences regarding the types of companies they choose to fund. Venture capital focuses on growing startups with high risk, such as those in the application and software sectors, often favoring companies with robust management. Angel investors are generally more open in selecting startups for funding, considering various types of companies.
5. Investment Returns
Venture capital receives returns in the form of shares as per the agreement, along with equity positions. This means that fund owners obtain seats at the executive level and participate in directing the company’s strategy. Angel investors also receive shares or equity in the funded company, but they may not necessarily play a direct role in managing the company.
6. Screening or Selection Process
Before deciding to invest in a startup, both venture capital and angel investors conduct screening. However, their screening processes differ. Venture capital employs third-party entities with expertise in this area, while angel investors often conduct their selection based on their individual experiences.
7. Involvement in the Company
The final distinguishing factor is the level of involvement in the funded company. Both venture capital and angel investors expect high returns. However, angel investors usually act as mentors, with limited direct involvement in business governance. This is in contrast to venture capital, which tends to be directly involved in decision-making and may even seek leadership positions.
Understanding these differences will enable startup founders to determine the most suitable option for their startup, considering the advantages and disadvantages of each.
