Angel Investors VS Venture Capitalists
While getting a capital contribution from friends and family may be helpful, it’s often not enough to get a startup off the ground. Many founders reach a point in the early stages of their operations when the money runs out and they have to consider outside funding. This is when they are faced with the question of which one would be the best: angel investors vs. venture capitalists (VCs). There are distinct differences between these two forms of funding and one is not necessarily better than the other – they are simply different.
Fundraising is a daunting prospect for most entrepreneurs. It’s stressful because, in most cases, funding is crucial for scaling. However, raising funds takes valuable time away from the business. Part of the stress is deciding on the type of funding that would be best for the business. Let’s look at the factors that would affect a choice between angel investment and venture capital.
Angel investors are affluent individuals who invest their own money in startup ventures. The investment is usually in exchange for ownership equity in the company. These individuals normally have “accredited investor” status afforded by the Securities and Exchange Commission (SEC) to individuals who have a net worth of $1M in assets or more, or have earned $200k for the previous two years. Accreditation is not a prerequisite, but it does provide a way to assess if a potential angel investor is legitimate.
While many angel investors operate on their own, they increasingly work together and invest in groups. One example is Healthcare Investors LLC.
Angel investors are often successful professionals who promote their industry by investing in early-stage startups. In the health industry, angel investors are typically physicians, scientists, and med-tech entrepreneurs who have already had a successful startup.
Venture capitalists are professional investors that invest money on behalf of high net worth individuals, corporations, pension funds, and foundations. They are known as limited partners and they don’t invest their own money.
They are experienced fund managers who invest venture fund capital in high-potential startups with the aim to earn a competitive return on their investment.
Venture capitalists typically invest higher amounts than angel investors. Seeing that angel investors invest their own money, the investment amount is typically lower than $1 million. They often invest between $25,000 and $100,000.
Angel investors help businesses that seek between $250,000 and $2 million. According to research, there are approximately 400,000 angel investors who invest in 50,000 early-stage healthcare startups in the US.
The amount of money invested depends on the funding round, the industry, and the goals for the startup.
Typically the amounts are more or less as follows:
- Seed round: $1 – 3 million
- Series A: $3 – 10 million
- Series B: $5 – $25 million
- Series C: $10 – $100 million and more
Venture capital funding has provided capital for hundreds of startups developing technology-enabled digital health products, including wearable devices, mobile health applications, telemedicine, and personalized medicine tools.
In 2017, venture capital firms invested more than $11.5 billion in digital health, which includes patient-facing devices, practice management software, and data analysis services.
Stage of investment
Angel investors specialize in early-stage businesses, with their funding supporting technical development and early market entry. They tend to choose businesses that are active in their industry. Unlike venture capitalists, they don’t insist that the business must have a proven track record of success. They will invest in an enterprise even if it has not proven itself yet. This fact, plus the fact that they invest their own money, means they take on more risk than venture capitalists.
Venture capitalists, on the other hand, invest in more developed companies. They are only interested in companies that already have a viable product or a viable number of customers. They can see the beginnings of success and a promise of growth, so they invest to help such companies succeed on a big scale. They are even more eager to support a venture financially if it has the potential to disrupt an existing industry.
What they offer in addition to capital
The level of support that angel investors provide differs from startup to startup, investor to investor, and industry to industry. Some angel investors only provide financial support and then withdraw, while others who are committed to their industry or to the entrepreneur’s vision, may share their knowledge and experience. If you are looking for a guiding hand, look for an angel investor who is an expert in their field. It’s also wise to look for someone who is well-connected in the industry and would be prepared to make introductions. An angel investor will provide guidance but won’t get involved in the day-to-day running of the business.
Venture capitalists have a vested interest in companies they invest large sums in. VCs will play an active role in the company to help it scale. They will get involved in decision-making, possibly influencing the focus of the company and expect to have a say in key recruitment decisions. In some cases, they will insist that the founders establish a board of directors and demand a seat on it. The reason for their involvement is to help the company grow so they can earn a return on investment for their fund members.
What are the stakes?
Both venture capitalists and angel investors want business equity in return for their financial investments. Angel investors invest a lot of their own money and in return, they get equity or convertible debt. Since they are investing their own money, angel investors usually feel entitled to insist on some form of equity in the startup.
VC firms can demand a higher equity stake in a startup because they invest larger sums. Depending on the situation, they could also ask for some control in how the business is run.
So, in both of these funding methods, the founders are giving up a part of the ownership in their business. It has happened that entrepreneurs were so eager to obtain funding and so unsure of the future success of their venture that they parted with too much of their business and ended up with a minority state in their own, very successful business venture.
Also, both funding options don’t require the founders to pay back the money in case the startup fails. Neither angel funds nor venture capital funds are regarded as a loan, so in this regard, both are beneficial for founders.
Angel investors tend to favor the industries that they already have skin in. They mostly invest in a sector that they have experienced and are in favor of supporting businesses that they understand. Since starting a retail business is quite a common trend, many angel investors invest in this sector where they feel they can add real value. Healthcare is at the top of the list, due to its promise of high returns.
They invest in all sectors, but the ones listed above are the most prominent. According to Growthink, the breakdown is as follows:
- Healthcare: 23%
- Other: 21%
- Software: 20%
- Retail: 13%
- Biotech: 9%
- Financial Services: 8%
- Industrial/Energy: 6%
VCs tend to focus on industries or sectors that are more likely to grow big and yield a massive return. They must have an effective management team that can guide the business to scale up to huge sales figures in a short time. They are only interested in markets that hold strong potential. If you are developing a great product or service for a limited market, VCs won’t be interested in investing.
One of the reasons for this insistence on sales volume potential and strong competitive advantage is the low rate of success that VCs experience. According to research by Shikhar Ghosh, a senior lecturer at Harvard Business School, the vast majority (75%) of venture-backed startups fail.
In real terms, three or four out of ten fail completely, another three or four only yield enough return to cover the original investment, and only one or two yield the returns that investors had hoped for.
The most desired outcome for VCs is if the company goes public or is acquired for a huge sum.
Like angel investors, VCs also tend to put money on startups in industries that they have some expertise in. They work with huge sums of other people’s money, so they tend to invest in what they know.
According to Statista, technology (the internet industry) garnered the most investment in 2021, followed by healthcare, computer hardware and services, and mobile and telecommunications. Technology by far outstrips all other sectors in terms of investment value, with fintech and biotech also attracting a lot of funding.
When deciding on angel or VC investment, a range of factors needs to be considered. A very early-stage venture that needs finance and money to get off the ground would probably benefit from angel investment, while a more established business that is already showing substantial growth potential will attract the interest of VCs. For the risk they are taking, VCs will expect partial ownership and a say in strategy and operations.