The project is growing. You are doing good. Now you need funds — so which one to choose for funding? Venture Capital or Angel Investor?
The gigantic hurdle an entrepreneur faces while setting up a new endeavor is getting funds for his project. If an entrepreneur is not able to arrange for the required amount of capital at the appropriate time, his business plan may just remain a blueprint and never see the light of the day.
However innovative and promising a business concept may seem, banks and traditional lenders are usually unwilling to source seed projects. Out of the different sources of capital available to entrepreneurs and businessmen, venture capitalist and angel investors are the widely used ones.
Who is an Angel Investor?
An angel investor is someone who provides financial backing to entrepreneurs expecting returns higher than traditional investments. Usually they are successful experienced businessmen, who along with capital provide management contacts and expertise to the entrepreneurs. Thus they act as mentors and advisors to the business they are investing in.
What is Venture Capital (and Venture Capitalist)?
Venture capital is long term finance provided to business with perceived growth potential. It is invested in exchange for an equity stake in the new business.
It is provided for start up business as well as expansion of businesses. The process of acquiring venture capital funds is different than getting loans from traditional sources.Venture capital has a right over the interest on loan and its repayment irrespective of the success or failure of the business.
Venture Capital or Angel Investor?
Many entrepreneurs face a basic question about who they should approach to finance their business - venture capital or angel investors. There is no thumb rule regarding the type of firms each of these supports with finance.
An entrepreneur can look for an angel investor or go to a venture capitalist with his project. The entrepreneur can analyze his project over the following factors to choose on the source of finance:
- Size of the project - Venture Capitalists prefer to invest in companies that have a high potential for rapid growth and there are chances of expansion or going on an international level. Meanwhile, angel investors invest in smaller projects and do not emphasize on rapid growth; they are prepared to wait until the business starts getting returns.
- Type of project - If a person has a strong confidence in their business concept and needs extra support to make a well timed kick off into the market, he can take help from venture capital. But if a person is just taking up a business idea with a ‘Let us see how it performs’ attitude i.e. as an experiment initially, he should approach angel investors.
- Amount of financing required - Project that requires a large amount of capital is often financed and preferred by venture capital, while angel investors favor smaller finance requirements.
- Entrepreneur’s business experience - Venture capitals play on the safer side and choose business ideas of experienced and well qualified entrepreneurs. Angel investors emphasize on the business idea and if they are convinced with the idea, they support novice entrepreneurs.
- Return Expectation - Venture capitals invest other people’s money and hence their main motive is to earn huge profits in a short time. Angel investors invest their own money and hence there is no set criterion for return on investments. They do the financing mainly for a noble cause and hence are content with comparatively smaller returns over a period of time
- Control - Venture capitals stay involved in the business and demand a stake in the equity or position in the board. Angel investors offer management contacts and expertise but are usually not involved in the functioning of the business.
- Exit timing - A venture capital will lock the deal for a longer time, around 10 years. Angel investors enter in to an exit agreement of 4 - 5 years.
- Due diligence and investment process - Venture capitals are a trained team of professionals hence they follow a strict and criteria based due diligence process. Angel investors adopt a more personalized approach towards the entrepreneurs.
An understanding of the differences between venture capital and angel investors simplifies choosing the appropriate source of finance.
A mix of the two sources is also popular where the initial funding of a business is done using angel investors and for expansion venture capital is taken. The decision is entirely in the hands of the entrepreneur and his needs.
Wish you the best.