When we look at major companies like Mint.com, it’s challenging to imagine them as small start-ups in need of funding. However, in its early stages, Mint received angel investments— funding from high net worth individuals made in exchange for company equity.
The exchange of funding for equity creates quite a bit of overlap between angel investors and Venture Capital (VC) funds, leading some small businesses to wonder which is best for their needs. In the article below, we will uncover the main differences between these investing types in addition to comparable alternatives that might work for you.
What Makes Angels Special
For most Venture Capitalist firms, Banks, and other sources of traditional funding, you need to prove your company is reliably profitable with a trajectory for major growth. This means small, new, or niche businesses are often disqualified from these types of funding due to their high-risk, low-yield nature. On the other hand, angel investors typically invest in early stage small businesses, hoping for growth and profit, but not on the same scale as large investment firms.
The reason for this is because they are rendering funds from their own pocketbook rather than a pooled sum. This gives them the flexibility to set their own expectations and help in business ventures that may otherwise have gone overlooked.
Angel vs. VC
As mentioned before, there is overlap between how the two types of funding structures work. However, the differences as outlined below shed light on the more subtle differences in flexibility and forgiveness that really set the two systems apart.
|Angel Investor||Traditional VC|
|Funding||Wealthy individuals can become accredited investors after reaching the right minimum thresholds. As such, Angels use their own money to fund projects.||Here, a variety of investors pool their resources to have a sizable central fund. This fund is then given to investment specialists to manage, much the same way an investor handles another person’s stocks.|
|Investment Stage||While technically found at many different stages of funding, angel investors tend to specialize in the earlier stages of business, such as Pre-seed, Seed, and Series A funding.||Because VC firms rely on the success of their investments to remain viable, they often concentrate their funding on larger companies that have some level of establishment, following, and reliability. This makes VC firms more common in series funding but nearly non-existent in seed money stages.|
|If Your Business Fails||Unlike a loan, angel investors normally don’t expect a failed business to reimburse them on funding. This is because Angel investment is not a loan, but a purchase of company equity.||When a VC firm assesses your business and sees potential for failure, it decreases your chances of gaining funding exponentially. This is because while a VC won’t force you to pay back their funding, they fully expect your rate of return to be high enough to generate meaningful profit.|
|Equity Agreements||Both Angel investors and venture capital firms fund companies in exchange for equity. This means that your investor will retain the right to involve themselves in your business decisions, something that can become problematic if there is disagreement on the trajectory of the business.||Both Angel investors and venture capital firms fund companies in exchange for equity. This means that your investor will retain the right to involve themselves in your business decisions, something that can become problematic if there is disagreement on the trajectory of the business.|
|Industry Knowledge||Commonly, angel investors stay within their industry of expertise. This gives you first-hand access to many years of experience from an individual successful in the same industry you’re just starting to break into.||VCs often offer a large network, but personalized aid is sometimes challenging to find. This is because VCs work with investors to invest the money of others, making direct industry knowledge more challenging to come by.|
Alternative Funding Methods
Angel investment and venture capital are heavy hitters in funding, in part, because of the press they receive. However, these are not the only methods of funding available. In fact, depending on your desired level of control and business type, other methods of funding may even provide a greater value in reaching your goals. Below are three commonly used alternatives.
- Traditional Bank Loans
A bank loan is likely the type of funding you are most familiar with in your daily life. This type of direct financing is how we are able to purchase cars, houses, and other valuables without having all the money on hand.While you can take out a traditional loan for your business, there are risks. For one, if you default on payments you will be personally liable, potentially ruining both your credit and personal finances. Similarly, bank loans are notorious for interest rates that may be oppressive for many early-stage entrepreneurs.The upside, however, is that you retain full ownership and decision-making capacity within your own company. This means you will never have to consult with health individuals or business people about decisions in the growth and scale of your small business.
- Crowdfunding Platforms
Over the years crowdfunding platforms have grown in popularity, leaving us with big names such as GoFundMe and Kickstarter to help individuals gather donations to get their ideas off the ground. While the pros and cons of crowdfunding could be an article in and of itself, one of the greatest hindrances of this structure is how unreliable and slow money trickles in.Unfortunately, the crowdfunding success stories we often hear about through social media are the exceptions to the rule— the one in a million case where an individual gains a huge following, exposure, and collects funds to match. For most businesses, this never happens, leading to entrepreneurs wasting their time as they wait for a campaign that ultimately never gains traction.
- Revenue Based Financing
Revenue-based financing is a flexible model that draws from the benefits of many other systems. Here, individuals are given funding in exchange for royalties rather than in exchange for equity.This system works by business owners agreeing to pay back their investors a percentage of their revenue, meaning their monthly payments fluctuate in parallel with their business profits. The result is businesses that can still make their own decisions while not having to worry about defaulting on payments should they have a slow month or seasonally variable business.
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