If you’re in the market to grow your business, you may be thinking about offering an equity stake to investors. But you might also be unsure about what types of equity stakes exist.
The two primary methods of equity investment for smaller firms are known as angel investing and venture capital investing. Because of the cultural prominence of venture capital firms in technology news lore, for example, many entrepreneurs know of the term – and some may think of “venture capital” as a synonym for early-stage investing. However, the term doesn’t apply to all early stages. Venture capital is very distinct from angel investing.
Let’s look first at what the two methods share in common. Each is a method of receiving infusions of cash in return for equity in the company. Each type of investor will require a sophisticated pitch about the business, with sufficient information and background material to make a decision. This material should outline your goals, objectives, the qualifications of senior business leaders, and financial results.
Some investors require a minimum of three years of past financial results. All will require financial projections for the next several years. The pitch should include information on the competitive landscape, issues specific to your industry that could affect your business (such as cost of raw materials), and an analysis of your strengths, weaknesses, opportunities, and threats (SWOT).
Now, on to the differences.
The term “angel investing” comes from the Broadway stage, where angel investors were (and still are) individuals who swoop in to underwrite the costs of a production before revenue from ticket sales roll in. The term is in use for wider swaths of businesses simply because angel investors are still frequently sole individuals.
Angel investors also frequently have a personal interest in the success of a company. They can be friends or family of the founder or of early employees. People retired from a business also often become angel investors, simply because they are interested in the sector, its products, or mentoring new people in it.
Successful entrepreneurs may develop an interest and talent in spotting new businesses, and want to become angel investors.
Venture capital occurs at a later stage of company development.
Once a company has passed the $5 million to $7 million valuation range, venture capitalists often become interested. In other words, venture capital is the next stage of equity investment beyond the angel.
Although some individual venture capitalists are well-known, venture capital comes from firms, not private investors. Venture capital firms choose companies to fund that are likely to eventually go public, with stocks traded on major exchanges.
They are also likely to get far more involved in issues of operation and governance. They can, for instance, provide introductions to people who can serve as mentors or sit on the board of directors. They provide strategic guidance, advice on markets and trends, and more.
Venture capital firms are often highly specialized. They may focus on a region (such as Silicon Valley), an industry (such as biotech or artificial intelligence), or a specific company stage.