Part of Our Research Series for Angel Investors
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Angel Investor? VC? LP? GP? What’s the difference between all these types of investors? Simply put, it boils down to when investments are made. Angel Investors are often the first investors into a company (who may or may not invest in or follow after founders’ friends and family — some of whom may actually be Angel Investors).
Angels are wealthy individuals who, either independently or together with others, invest in the earliest stages of startups. As mentioned above, Angels may be a friend or family member of the founder(s) and that also facilitates why they invest early.
Why Do Angels Invest Before Venture Capitalists?
So why do Angels often get the first crack at investing in startups? It boils down to economics. First, Angels, as individuals, are simply often limited in the amount of money they can invest — and companies at the early stages don’t necessarily need tens of millions of dollars to develop their first products and generate initial traction.
This, however, does not capture the entire picture. The key difference between these two investors is that Angels invest their own capital, whereas VCs invest capital from others (in addition to a bit of their own) — so VCs have a higher threshold for generating returns, because they need to both pay themselves and their investors as well as show enough skill to continue to attract capital.
Therefore, you will commonly hear VCs talk about whether or not the company, despite its prospects for success, has the potential to generate a large enough return to warrant investment.
It may feel strange that an investor would turn down what appears to be a phenomenal investment opportunity just because the potential payoff wouldn’t be large enough. This captures part of the central risk when investing in startups — the majority of them fail. With that known variable, VCs therefore need to ensure the relatively few winners that have will be large enough to generate a return that sufficiently offsets the losses in a portfolio. Therefore, potentially small winners need not apply — but that doesn’t necessarily have to be the case for Angel Investors!
Angels can write checks for as little as $1,000 and as large as $150,000+ and will likely represent the source of funding for companies raising capital in the amount up to $1-$2M. VCs will often pass on upwards of 99% of the deals they review, while Angels, on the other hand, will invest in as many as 30% of opportunities.
Angel vs VC Investments
Money is money, right? Sort of. Founders should seek what is called “smart money” when sourcing investors. This means that in addition to the actual cash invested in the company, they’re getting value from their investor that may come in the form of management expertise, market expertise, an ability to introduce potential customers, other investors, and many other benefits.
Therefore, as an Angel Investors, it behooves you not only to invest in companies where you can add value beyond cash, if you’d like to, and be able to market that to potential founders when looking for companies in which to invest. Keep in mind that rational founders may want to put off raising external capital to retain their ownership, limit the number of outside voices in the room, and manage to goals and benchmarks that perhaps they would otherwise set differently.
VCs, by nature of being a fiduciary, may have different motivations from founders and Angels. It is therefore critical that early investors and founders are on the same page when it comes to product roadmaps, time to market, and exit strategies, among others.
Because Angels invest only in early stage companies (as a primary investment), the due diligence practices will differ as well to reflect the higher level of uncertainty. The focus will be much more on the quality of the founders and their abilities and experiences than on the product and current customers.
Lastly, the types of investments differ. More and more, Angel investors are investing via SAFE notes and other simplified investments that, in exchange for capital, promise future equity considerations upon specific events (like raising capital from a VC). VCs, on the other hand, will include more complicated deal economics and terms within their investment term sheets — and companies in general, as they mature, may seek out alternative sources of capital, including debt financing.
What About Angels Investing Alongside VCs?
Depending on the maturity of the company, Angels who invested early will have the opportunity to continue to invest in the company as it grows — which means investing alongside a VC. This brings into picture some of the complications that Angels should note.
There are a couple important considerations for angel investors to know when dealing with VCs:
- Risk of Co-Investing with VCs: Often, angels avoid early-stage financing rounds that include capital from VCs because in future rounds, the VC will have more power given their already initial investment, which can minimize the influence of angel investors (who presumably are investing less as a percentage of ownership). VCs often have longer time horizons and can therefore hold out for higher return multiples, so angels need to understand and ensure they’re aligned with all investors as much as possible when it comes to reasonable expectations around exit goals, future funding goals, etc.
- Benefits of Co-Investing with VCs: On the other hand, if VCs are investing early, especially prominent ones, it can be a beneficial signal to other investors. This can mean other investors are easier to find, making raising capital easier, and eventually providing more support to the company, ultimately increasing the success probability. Be mindful, however, of the risks — as mentioned above, too many VCs may crowd out angel investors and if VCs don’t commit to future rounds, a good signal can turn to a bad one if VCs have soured on the company’s future prospects.
Growth is Good: Keep an Eye on the Prize
In the end, Angels and VCs are chasing the same goals — generating more capital down the road that was invested today. The path to exit is rarely the same for any two companies, and it’s important that Angels understand the differences between their investing partners in order to both protect their own interests and dutifully support their companies.
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