Financial Jargon Busting Angel investors vs. venture capitalists

When making a financial decision for one's growing business, it is important to understand the key differences between the types of investors in this venture. While getting an investment from friends and family might be helpful, a startup company may need some additional capital (funding) to get the business off the ground. Many companies will consider angel investors or venture capitalists (VCs) as alternate sources of funding. However, businesses should be aware of a few differences in their approach.

Have you ever watched the show Shark Tank? If yes, you might have heard the term “angel investor” thrown around. But what exactly is an angel investor? Usually, an angel investor refers to an affluent, accredited individual who invests their own money in startups or companies in the early stages of development; this is in exchange for equity in that startup. Angel investors may contribute their business expertise to help the company, but they are generally content with receiving an equity stake for the funds they contribute.

Angel investors can be individuals familiar with the funding opportunity – such as family members or friends – or can be a group of angel investors who pool their resources in search of potential investment opportunities.

Since angel investors invest their own funds, it is preferable that they meet the criteria set forth by the Securities and Exchange Commission (SEC) to be defined as accredited investors.¹ Currently, this is not a requirement – just a standard that a prospective fundraiser should use to gauge the credibility of a potential angel investor.

Venture capital funding is a more process-driven approach to investing. Generally, VCs get involved in the fundraising process after angel investors. One might say that angel investors “find” a lot of the investments that VCs will want to get involved in. Once again, the payoff is an equity percentage of the company that receives the funds.

Typically, individuals or entities that want to get into venture capital funding will form a firm with a limited partnership (LP) structure. In this type of a partnership, the roles of the investors and management is clearly defined and, in most cases, separated. The investors in a VC firm are its limited partners, while the firm’s management are its general partners. It is important to understand that these investors are “outside investors” and do not work in the firm but, instead, invest in the firm – similar to how a hedge fund works.

These limited partners are often professional investors such as pension funds, sovereign wealth funds, endowments and affluent accredited individuals, although that is not a requirement. The VC firm itself comprises several employees, aside from investors, whose aim is to provide the support needed to ensure that the fund receiver’s business can grow

The managing partner in a VC firm can be an investor as well, although that is not necessary. Their function is to guide the pooled funds into profitable investments.

All companies require funding (capital) to function. That said, funding is especially key for a startup’s survival. So, which path should startups follow to get the capital they need – angel investor or venture capitalist? Like many financial scenarios, there is no correct answer. Rather, it depends on what stage the business is in.

As a general rule of thumb, if an entrepreneur has an idea for a company, then an angel investor might be the way to go. However, if they have already started a company and need additional funding and/or expertise to make it grow, then a venture capitalist might be the answer.