Too many entrepreneurs tell me they are looking for an investor, and can’t differentiate between venture capital (VC) investors and accredited “angel” investors. They argue that the color of the money is the same from either source. They fail to realize that the considerations are quite different for each, which can make or break their investment efforts, and ultimately, their startup.
Let’s consider some basic definitions. Accredited angel investors are non-professionals investing their own money, while venture capitalists are professionals who invest someone else’s money (usually from large institutions). The amounts from angels start as low as $25K, while minimum venture capital amounts usually start in the $2M range.
That doesn’t mean you should always go for the big bucks first—the reality is quite the opposite. Angels are more likely to fund new entrepreneurs, and early-stage or seed rounds, while VCs tend to focus on entrepreneurs with a successful track record and later-stage rounds. Of course, between these extremes is a large overlap of interest and potential.
More importantly, the focus on numbers tends to hide other more subjective issues that could be more important for any given startup. These considerations include the following:
- How much ownership and control are you willing to give up? VCs tend to demand more control of your spending and strategic decisions, with required board seats and lower valuations. Angels will likely agree to simpler term sheets, better valuations, and less restrictive terms on potential dilution, voting rights, exit options, and executive roles.
- How big is your startup opportunity? If your targeted business plan opportunity is not at least a billion dollars, most VCs won’t even be interested. Both angel and VC investors look for solutions that scale easily (product versus service businesses) and expect revenue growth that can reach the $20M-mark by year five.
- How large is your projected financial return? VCs look for a 10-time return on their investment in 3-5 years, or a 30 percent annual IRR (Internal Rate of Return). This may sound high, but VCs know that up to 9 out of 10 startups fare poorly, so they want one big win. Angel investors wish for the same return but may accept a 5-time deal.
- How many investment rounds will be needed? Angel investors are usually constrained to making a single investment per startup, but very few entrepreneurs make it to cash flow positive on a single round. VCs tend to protect their initial investment, and they have the resources to make several multi-million-dollar rounds as required.
- How experienced is your team? First-time entrepreneurs rarely catch VC interest, unless they have one or more people on their team who have a track record of startup success, in the same business domain. Angel investors often have an emotional motivation to give back and assume their own expertise and involvement will ensure success.
- How good are your connections in the investor community? Sending unsolicited business pitches to every Angel and VC investor you find online is a complete waste of time. You need a warm introduction for most VCs to get their attention. For angel investors, you only need to do some local networking to get interest.
- How much help do you expect and need? Both VCs and Angels can and will help you, but VCs are likely to be more “hands-on.” They usually have partners focused on a given business area, with current insights, executive connections, and the ability to bring in new team members. If you are looking for money alone, angels are the better alternative.
If your startup can’t yet relate for any of these considerations, then your alternative is that popular first tier of investors, called friends, family, and fools (FFF). With these, you are on your own to negotiate amounts, valuations, and roles. These are people who believe in you personally, without evidence of previous startup experience, current traction, and valuation.
In all cases, investors tend to invest in people, more than ideas, or even the stage of execution. They seek a win-win deal, with entrepreneurs who demonstrate positive chemistry and open communication. The color of any investor’s money may look the same, but it won’t help you if the price you pay is higher than the value it brings.
Reprinted by permission.
