Funding Sources: Differences between Venture Capital and Angel Investors
For startups it's important to understand the differences between funding from venture capital firms and angel investors. This article takes a look at these differences and discusses some of the mistakes that startups make when securing funding.
The differences between VCs and angels are nuanced, but typically, there are some fairly common differences between these two types of investors. Understanding these differences and maintaining proper legal representation can often prevent startups from agreeing to terms that may hinder their future.
Source of Funds: Generally, angels invest their own funds and VC firms use pooled moneys from various sources including third-party investors.
Investment Structure: A VC firm generally purchases preferred stock, with certain protective provisions and required terms. Whereas, the options are typically broader for an angel investor and could include preferred stock, common stock, a loan, a loan with warrants, a convertible loan, etc.
Diligence: A VC likely will have a long diligence list that is similar for every deal, and some items may not be relevant to a startup's business. Whereas, an angel may request whatever diligence items they think of over time or whatever the angel’s advisor recommends.
There are many reasons for this difference in diligence. One is that investing in companies is typically an angel investor’s “second” or “part-time” job, whereas it is the primary purpose of a VC firm, which leads to a greater focus for most VC firms when conducting extensive due diligence. Another is that an angel is generally investing for themselves, whereas a VC generally has a fiduciary liability to its limited partners/investors. Before seeking funding, startups need to be prepared to disclose to potential investors what is necessary for legal compliance, including applicable securities laws.
Process: In general, a VC will prefer a set process (although many can be flexible for the right situation) and a quick timeline. An angel may rely on the company seeking funding or the angel’s advisor(s) to determine process and timing.
Size: Angels tend to invest smaller amounts than VC firms. However, there are exceptions, such as angels with vast amounts of wealth (e.g., family offices) or angel groups (e.g., an angel investor syndicate that pools money for larger investments).
Timing: Angels will often invest very early. VC firms generally don’t like to fund something at the idea stage and instead prefer a finished initial product, the first dollar of revenue or some traction in the market.
Decision Making: Angels may make their own decision or with the help of advisor(s). A VC firm typically has investments approved through committees to avoid making an investment based on one person’s excitement.
Post-Investment Involvement: A VC has many investments to watch, and may want regular reporting, the right to approve certain actions, and one or more seats on the board of directors. An angel’s involvement may vary from little involvement to too much involvement – in the eyes of the startup. Involvement often depends on the angel’s expertise, availability, other investments and a host of other variables.
Depending on the arrangement, an entrepreneur may find that an angel investor or VC firm is incredibly useful to advancing the startups' goals via board participation, contributing higher levels of experience, and obtaining access to portfolio companies and other senior executives.
What a startup is able to obtain from a VC or angel will depend on the knowledge possessed by the principals and their negotiating leverage and skill. However, many startups make major mistakes when looking for funding, including but not limited to:
- Giving up more power than necessary
- Giving too much equity to an angel, so that not enough is left for a later “Series A” round of funding from a VC
- Choosing the wrong investor(s)
- Lacking proper documentation of corporate records and business agreements for investor review
Angel investors or VC firms may have greater experience and leverage (they have the money after all), but startups are well-served by engaging counsel to advise them on the deal so the startup's business, financial and future interest are protected.
Michael Howard helps companies mitigate risk, resolve disputes and capitalize on opportunities. His extensive background in business, management, technology, consulting and real estate allows him to meet the needs of businesses in various stages of growth, from startup/formation and rapid expansion, to exit transactions/strategies and, if necessary, restructuring or dissolution. Michael is a partner at Stinson Leonard Street. Contact: email@example.com