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Venture Capital vs. Angel Investment: Learn How They Differ to Make the Right Choice
Every entrepreneur needs to make the venture capitalist vs angel investor distinction because of the distinct roles they play in a startup’s funding journey. Clearly both are integral to financing options as evidenced by the funding frenzy in 2021, when angel investment and venture capitalism increased substantially despite the aftereffects of the pandemic. Let’s discuss the differences between angel investment and venture capital, to help you decide which option best suits your business.
What is a Venture Capitalist?
Venture capital refers to financial investments in a company or a startup with high growth potential to help them reach a significant size, credibility, and fame. A Venture Capitalist (VC) buys a stake in an entrepreneurial venture, works with them to help it grow, and exits through a listing on the stock exchange, or through a management buyout or by selling their stake to another buyer.
What is an Angel Investor?
Angel investors help startups build their businesses by financing them at the early stages. Unlike VCs who can borrow from institutions to raise funds, angel investors typically use their own wealth to finance entrepreneurs, participating in the growth without holding direct operational control.
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How Do Venture Capitalists Work
Venture capitalists study the granular details of a business plan before making the decision to invest. A company’s management pitches the most favorable business outcomes and the plans to achieve the same.
The next step involves investment negotiations to reach the fundamental Memorandum of Understanding (MoU) between the VC and the company. The post-MoU processes that the VC undertakes are the following:
- Thorough industry research
- Studying the growth rate of markets
- Studying the performance of competitor businesses
- Estimating market size, product life cycles, and distribution channels
Once this is complete, the final stage involves full disclosure of the company details including shareholders’ agreement, veto rights of the investor, and company audit, among others.
How Do Angel Investors Work
Angel investors step in in the early stages of startups. That is, they invest in the seed rounds of financing. Subsequent stages, such as the Early Traction stage (Stage A) or the scaling stage, also find considerable support from angel investors.
A basic rundown of the process involves the following steps:
- Basic communication between the investor and the startup management via seminars, referrals, and other formal business meets
- Interviewing of the company founders by the investor to map development and success
- Terms of investment, investor rights, and exit strategies for the investor being formulated
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The Typical Angel Investment Strategy
An angel investor typically strategizes the investment practice through the following three steps:
1. Set Up the Investment Horizon
The investment horizon refers to a tentative number of years an investor holds on to their stake in a business before selling it. If angels are new to the business, they typically start with a vision of four or five years and evolve to a long-term network of investments that enhance profitability and mitigate each other’s risks.
2. Understand the Risks of the Market
Amateur angel investors can get derailed by the uncertainty of the market, resulting in risky deals. Only a balanced understanding of the risk involved with every venture will give a realistic investment potential for the investor.
3. Choose the Right Sector
Always start by working with domains you are interested in or are confident about. As angel investors help companies in their early developmental stages, your managerial or administrative expertise will help companies optimize their resources. The best sector of investment for an angel is the domain which they already know a lot about, providing businesses with a mix of stable finances and ingenious ideas for growth.
Angel Investors Vs. Venture Capitalists
The venture capitalist vs angel investor comparison can be made along these parameters:
How They Work
Venture capitalists tap into a steady pipeline of funds garnered from corporations, pension funds, hedge funds, foundations or institutions, and wealthy individuals. VCs typically become limited or general partners in a company, working closely with entrepreneurs to monitor the financial health of their investment.
On the other hand, angel investors are accredited investors who use their own money to help build someone else’s business from the ground-up. Also, as angel investors invest a lot less money than VCs, their terms of collaboration are often more flexible.
When They Invest
Angels usually invest when businesses are starting out, enhancing their chances of success in their initial stages of development. Venture capitalists seek companies with a minimum operating capital base and projected formidable growth—either in the growth stage or the maturity stage.
In the venture capitalist vs angel investor comparison, a VC invests a lot more money than an angel investor. According to a 2022 Nerdwallet report, angel investors should have a minimum annual income of $200,000, while the bar for investment amounts is as low as $1,000. Venture capitalists invest millions to make an impact on the business, with funds starting from $1 million.
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Expectations of Return
As angel investors back a company from its earliest stages, they demand ownership of the company that ranges between 25% to 30%, notes a Hartford report. VCs do not have a fixed percentage of ROI, and the return rate increases with the favorable growth potential of the company. However, the National Bureau of Economic Research has stated that a 25% return on a venture capital investment is the average.
According to Betaboom, here are the top angel investors in the USA in 2021:
|Name||Investment Count||Exit Rate (percentage)|
Forbes ranks these as the top U.S. venture capitalists from the year 2021:
|Neil Shen||Sequoia China|
|David Frankel||Founder Collective|
|Chris Dixon||Andreessen Horowitz|
|Richard Liu||5Y Capital|
To sum up, if you are looking for investment or are hoping to build a career as an investor, it is important to know the difference between venture capital and angel investment. We’ve given the key distinctions in this blog, but you can learn more about the venture capitalist vs angel investor comparison by enrolling for the finance courses on Emeritus, offered in collaboration with leading global experts. This will help you decide on the opportunity you wish to pursue.
By Bishwadeep Mitra
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