Difference Between a Venture Capitalist and an Angel Investor
By Nikolina Cveticanin
June 19, 2023
Every day, entrepreneurs across the world come up with ideas that might turn out to be multi-million dollar businesses. Regrettably, those lightbulb moments quickly fade if there’s no financing available to see them through. Ideas keep vanishing because there’s no capital to bring them to life.
Fortunately, there is a way to navigate this issue. Our discussion of venture capitalist vs. angel investor will allow you to regard the above scenario in a positive light. We’ll compare angel investing and venture capital, learn their differences, and weigh the pros and cons that should help you choose the right one for your business or startup.
What Is an Angel Investor?
An angel investor is typically an individual or group of individuals with high net worths (surpassing $1 million) who invest in small or growing businesses. Angel investors usually invest during the early stages of a business, either before operations commence or right after. With angel investing, small businesses get a chance to secure seed funding. In return, angel investors can get convertible debt or equity in the business, become part owners and/or shareholders.
The Securities Exchange Commission requires that angel investors be accredited. Accreditation is important to ensure that the investor or group of investors are financially sophisticated. They should also be able to fend for themselves, especially in the event of a loss. In our comparison of angel investors and venture capitalists, we will see that this is one of the most salient points, as it protects investors.
To earn such accreditation, investors must meet either of the following two criteria:
- Earned an annual income of $200,000 for two years before the accreditation and has a high chance of retaining such earnings in the future. Where taxes are filed with a spouse or spousal equivalent, the income is pegged at $300,000 annually (a monthly income of $16,667 and $25,000, respectively).
- A net worth of over $1 million.
What Is a Venture Capitalist?
To engage in a venture capitalist vs. angel investor conversation, first, we need to look at the definition of a venture capitalist. Namely, a venture capitalist is an individual or corporate entity that invests in small and growing businesses with funds pooled from investment companies, banks, pension funds, and other sources. This means the money invested doesn’t necessarily belong to the venture capitalist. Investors in this category will also not invest at the early stages of the business but when they see potential or actual growth.
Investments by venture capitalists are considered high risk, but the potential for growth shown by the small business can easily offset the risk of a bad investment.
Difference Between Venture Capital and Angel Investing
Venture capital and angel investing have similarities in that they focus on small and growing businesses. There is also their preference for technology and science sectors because they tend to show considerable growth and provide more investment security. Moreover, both kinds of investment can earn a reasonable stake in the business, and options for conversion of debt to equity can be made available.
Regardless of these similarities, there are also notable differences that set them apart. This is why a comparison of angel investors and venture capitalists is indispensable before a business decision can be reached. Below are some aspects where their differences shine through.
Amount of Funding Available
An angel investor will typically invest hundreds of thousands of dollars because they are investing their own money. Venture capitalists, on the other hand, will invest millions of dollars because they have more access to a range of funds.
Types of Investors
As already stated, angel investors are wealthy individuals or groups of individuals with high net worths. Meanwhile, venture capitalists take on high-risk investments with funding from third parties.
Time of Investment
Angel investing is usually done at a more vulnerable point of the business, which is a higher risk. Businesses that have angel investors are generally in their early stages, before or right after operations commence. Conversely, venture capitalists prefer to invest in more established businesses that have higher chances of providing tangible returns. To be fair, this is not out of place, considering that the funds belong to third parties.
Level of Involvement
Regardless of the type of investor, there’s a desire to become involved in the activities of the business they invested in. The aim for both venture capitalists and angel investors is to have a firsthand idea of how their investment is being managed and the steps being taken to ensure their returns. Angel investors tend to become part owners and get involved in the day-to-day operations of the business. But, in some cases, they are satisfied with only providing financial support. Venture capitalists, on the flip side, prefer to get involved in the decision-making by being on the board of directors.
Due Diligence
Due diligence is one of the most important segments of any investment process for angel investors or venture capitalists. Angel investors will usually conduct basic due diligence checks because they own the investment sum and won’t be held accountable by third parties.
Venture capitalists are more prone to lawsuits in the event of reckless investments because of the fiduciary responsibility to their clients and other third-party institutions. For this reason, they are liberal with the resources that go into due diligence, preferring to ascertain in the preliminary stages that the investment doesn’t pose any risk.
Industries of Interest
As a rule of thumb, an angel investor will invest in an industry they are familiar with. This is either because they have made money in that industry, or understand the workings. Venture capitalists are more interested in industries they consider profitable.
Angel Investor Pros and Cons
Angel Investor Pros
- Angel investors are more willing to take risks with their own money by investing in businesses that have just launched operations or are about to do so.
- In most cases, angels only require a return on their investment at a future date of the anticipated growth of the business. This is more convenient than debt financing with a set payback date.
- Mentorship opportunities may present themselves because angel investors are familiar with the industry they have invested in. As startups need all the guidance they can get, especially when navigating challenges, angel mentorship is valuable.
- With angel investing, there is flexibility to convert the investment sum into equity in the business. This saves the business owner from having to repay bank loans when the business is going through a rough patch.
Angel Investor Cons
- Since angels invest their own money, their funds may be insufficient. The consequence is that a business owner will need to bring several angel investors on board and potentially deal with a slower funding process.
- Some angel investors may become difficult to work with when they insist on having a say in your business without having some level of ownership.
Venture Capitalist Pros and Cons
Venture Capitalist Pros
- Venture capitalists can and will most likely leverage their connections and experience in the industry to market and promote your business. This is a win-win situation for both parties involved.
- Just like angel investors, they may grow your company by sharing their industry knowledge and referring professionals to work for.
- Venture capitalists can also convert their investment sum to equity in your business and eliminate the need to pay back funds at a set time.
- They can provide more substantial amounts of money your business needs to grow.
Venture Capitalist Cons
- As is the case with angel investing, venture capitalists tend to have a say in your business due to the significant investment they’ve made. Expectations may get too high and can only be remedied through a balanced decision-making process.
- The likelihood of a buyout by venture capitalists is high. This may only be beneficial when you need the funds for a new business venture.
The Role of Private Equity
After the above comparison of angel investor and venture capitalist, a quick definition of private equity is important to address grey areas and possible similarities.
Private Equity Definition
Private equity refers to funds that are mainly interested in acquiring private companies not yet listed on the stock exchange. Private equity funds usually have high-net-worth or accredited individuals and firms coming together to pool capital towards investment. Entry into these funds is exclusive due to the large sums required. For example, the minimum entry requirement for some funds is $250,000. Once the required capital is raised, the fund is closed.
Angel vs. Private Equity
The key similarity between angel investors and private equity is that they have the same goal of investing in a business to get returns. They may do so because they believe in the potential the business possesses, wish to gain control of it, or to save it from failing.
On the other hand, the major difference between the two types of investors is that the angel is an individual who invests on a smaller scale, while a private equity investor usually does so on a larger scale. The intention of a private equity investor is also geared toward acquiring the entity to be invested in.
Venture Capitalist vs. Private Equity
The objective that both venture capitalist and private equity have is the same – to get returns. Private equity investors, however, are more interested in larger enterprises and companies that are well established. As discussed in this article, venture capitalists are open to investing in startups and businesses that show growth potential.
Moreover, venture capitalists are known to narrow their investment scope to tech and science-inclined companies, but this is not the case with private equity investors who prefer diverse portfolios. The sizes of their investments also differ, with private equity investments being higher.
Final Thoughts
Regardless of your preferred capital raising strategy, if you’re a business or startup owner, you should explore the benefits provided by venture capitalists vs. angel investors. Even though both classes of investors can help you grow your business, you need to weigh the pros and cons to determine which one is optimal for your company. The amount of capital required is also an important factor to be considered because the investment scopes of these classes differ.
No matter the class of investor you need to approach, be sure to conduct due diligence and prepare an impactful business plan that will increase your chances of securing the investment you need.