In many ways Angel Investors are looking for the same things as Venture Capitalists, but there are some big differences that companies should be aware of that will play a part in shaping their financing strategy.
An angel investor is a high net worth individual with a net worth excluding their home of $1 million or more, or who has an income of $200,000 per year (or $300,000 for a married couple) with the expectation that this income will continue into the future. Angels differ from Friends and Family who will typically invest very early on when all you’ve got is an idea and who will invest in YOU rather than in your company.
Venture Capitalists are typically formed as Limited Partnerships in which the Limited Partners invest in the Venture Capital fund. The fund manager is sometimes called the General Partner and the job of the General Partner is to source good deals and to invest in the ones that they think will return the most money to the Limited Partners.
Size of Investment: Angels investing as individuals typically invest between $25,000 and $100,000 of their own money. While there are deals that are more than $100K and less than $25K, this is the area most angels fall into. Angel Groups work to syndicate many angels together into a single investment that may average $750,000 or more. Angel groups are becoming more prevalent and are a great way to get investment more quickly and all at the same terms. Venture capitalists invest an average of $7 million in a company.
Stage of Investment: Angel investors are typically investing in deals earlier than Venture Capitalists. They don’t like to invest in anything that’s just an idea, so the entrepreneur starts with Friends and Family to finance the early stage of the company up to where there is perhaps a prototype or Beta versions of the product. Angel investors most commonly fund the last stage of technical development and early market entry. Venture Capitalists will then come in with a “Series A” investment to take the company through rapid growth and rapidly develop market share. VCs will help a company to grow until they are ready to go public or be acquired, so the dollars they invest will be increasingly larger and larger as the rounds progress.
Due Diligence: Angels range from due diligence that might include having coffee or lunch with an entrepreneur to doing more thorough background checks and research with experts. When angels invest in groups they tend to do more due diligence than they do as individuals. Venture Capitalists have to do a lot more due diligence because they have a fiduciary duty to their Limited Partners. Venture Capitalists may spend as much as $50,000 or even more to conduct thorough research on their investment prospects.
Decision Making: Angels make decisions typically on their own and are not beholden to anyone except perhaps their spouses. VCs will have an investment committee who will work together to make decisions so that they are as objective as possible and won’t be swayed by just one member’s excitement over a deal.
Returns: Angels are investing earlier than VCs and so they have a higher risk to take into account. Despite this, they tend to look for about the same kind of returns that VCs look for – something like 10X the investment over five years. The reason they look for such a high return is that half of their investments are likely to go belly up and not return anything to the investor. VCs and Angels want to see a return across their entire portfolio of investments that is 20-30% per year.
Time Frame: Most Angels and VCs look for an Exit, or Liquidity Event in which they get their money back, within three to five years. Some investments take longer, of course, but Angels need to get their money back and VCs are even more under the gun since a typical Venture Capital Fund has a lifespan of ten years, after which the fund must return all capital and profits to the Limited Partners.
Board Involvement: When angels invest as a group, there will typically be an angel from the group who will sit on the board and represent the investors’ interests. If the angel is a significant contributor, then they may stay on the board even after venture capitalists invest. In other cases, the VC will take the seat representing the investors and the angel may stay on as a non-voting observer, or may retire from the board entirely.
Angel vs. Venture Capital Strategy: Raising capital from Angels is hard work. The capital raise always distracts entrepreneurs from doing the actual work of building product and getting in contact with customers. Entrepreneurs should try to put off their capital raise as long as possible, so that they can build value and get a higher valuation for their company before raising capital and diluting their equity. Sometimes angel investment is a great way to get enough traction to capture the eye of a good Venture capitalist. Other times angels will continue investing and you might never need to go to a VC. Your strategy for angels vs. VC investment will include factors such as 1) your ability to work for extended periods with little or no income, 2) the availability of Angel Investing Groups in your area, 3) the number and types of VCs in your area. (e.g. do they invest in early stage companies, etc.) and finally, because money is an accelerator for business, you will need to determine the need for rapid development of product and market. If your project is highly capital intensive and there are others who are nipping at your heels, then you probably have no choice but to raise capital as early as possible. If your strategy involves starting with Angels and then going to VCs for Series A investment, keep in mind the following: 1) angels will usually want 20-30% of your equity for their investment so be sure to keep enough equity available for follow-on investments, 2) make sure your documentation is VC Friendly. Use standard term sheets (check out nvca.org for a good template). Your deal should look as much like other deals in terms of incorporation, term sheets, board structure, etc. in order to be attractive. 3) Try to eliminate or minimize participation of non-accredited investors in your deal. Even though you can legally have a certain amount of non-accredited investors in certain types of deals, it’s best to leave them out if you’re going the VC route.