Angel Investors vs Venture Capital: Which is right for your company?
There are several critical differences between angel investors and venture capitalists. In this post, we’ll dive into the structure and incentives that drive many variables in how angel investors vs. venture capitalists operate and why it should matter to you — a business owner.
1. The Money Invested
- Angels invest their own money
- Venture capitalists invest other people’s money, known as their limited partners
Why it matters:
Venture capitalists need to return money to their LPs typically within a ten-year timeframe. As a result, they may pressure you to grow at all costs. This can show up in many forms for a startup, but one example is setting overly ambitious growth expectations that force your team to work overtime and burn out. Another place it shows up is when they want you to hire more people, thinking more people = more growth, but this may result in your team scaling before you have product-market fit.
Another misaligned incentive with venture capital and the structure is they have less skin in the game. However, this is typically an easy fix since partners at venture capital firms are often required to invest personal capital into each fund they invest from to have significant skin in the game, similar to that of an angel investor. The commitment varies by firm, but it is usually at least 2% of the fund. For example, a venture firm is raising $100M with two partners — each partner must contribute $1 million to the fund.
The last reason why this matters is the outcome. An angel investor making a couple of yearly investments may be happy with a small acquisition and a 5x return. Since venture capital firms need a home run to return their fund, they may advise against a similar-size acquisition offer even if it’s in your best interest.
2. Why they invest
- Angel investors invest to earn a return but also to support causes and people they care about
- Venture capitalists invest to earn a return
Why it matters:
Due to the nature of the money they invest, venture capitalists must invest to earn a return for their LPs. On the other hand, angel investors can invest for broader reasons – to support causes and people they care about – and to earn a return. They may invest in small businesses to support their local community. They may invest in an anti-aging drug for dogs because they have a dog. They may invest in a friend just because they are their friend. Angel investors can invest for alternative reasons outside of just earning a return — and many do, especially if they invest small amounts of money. I learned this from looking at investor data while working at Wefunder, a crowdfunding investment platform.
3. When they Invest
- Angel investors typically invest earlier or alongside venture capitalists
- Venture capitalists can be the first check-in, but they tend to invest a little bit later compared to angel investors
Why it matters:
Angel investors are typically the first outside money to invest in a company. Many of these angel investors have prior relationships with the founder. For example, your former boss writes you a check for $25K when you tell them you are leaving to start a company. They can do so because they have a lot of information about your abilities — they hired and worked with you. A subset of angel investors also invest alongside venture capital firms. They follow the heat — they wait for a top-tier venture capital firm to invest before putting money in.
As more venture capital firms have been formed, competition at Seed and Series A has pushed firms to move upstream and invest earlier. Two that come to mind are Pear VC and Hustle Fund, which are known for being first-check investors. Investing earlier has additional benefits — founders often remember their first check and praise these investors if they become successful, and it shows LPs that you have strong picking abilities. That said, Hustle Fund and Pear VC are still the exception in the venture capital landscape. On average, angel investors typically tend to invest earlier than venture capitalists.
4. Investment Decisions
- Angels make decisions individually
- Venture capitalists typically need to get a certain amount of votes from the investment committee (other partners at the firm) to make an investment. The larger the investment, the higher the threshold will be for the votes.
Why it matters:
A venture capital firm may take 2-3 weeks to go from initial meetings to investment, whereas an angel investor may take 1-2 days. The top venture capital firms can push investment decisions through even for large rounds within a couple of days if needed — some rounds that come to mind include Front’s Series B (received 10 term sheets in one week) and Rippling’s Series E (raised $500 million in 12 hours). That said, these rounds are the exception, not the norm. On average, angel investors can make faster decisions because they have fewer stakeholders and no bureaucracy or processes they must follow.
5. Investment Size
- Angels typically invest $5,000 - $150,000 per deal
- Venture capitalists invest based on ownership targets, and these are typically much larger sums of money
Why it matters:
Venture capitalists need to size their bets. They may pass on the deal if they can not secure their desired ownership target in the startup — so it’s crucial to understand round construction and save space for the top venture capital firms you’re courting to take up most of the round. For example, if you plan for 20% dilution in your Series A round and take money from two small funds that invest for 5% ownership each, that may cut you out from any multi-stage fund targeting >15% ownership at each round.
The desired ownership target is based on fund math and the power law — a venture firm will model out how they can produce significant returns based on exits from 2-3 startup investments that hit while the rest may go to zero.
Another consideration with investment size is your time as a founder. It may be easier to secure one large check from a venture capital firm than it is to source and close 20 angel investors who can write you enough small checks to total the same amount. Larger checks and more money can buy you the time you need to focus on building your company and hit the significant milestones needed to allow you to raise your next round. As a general rule of thumb, if you need to raise more than $1 million, then it is likely a better use of your time to find and convince an institutional investor rather than doing a party round filled with 10s of angel investors.
6. Rights and Control
- Angel investors typically do not get any control (board seats) or rights (liquidation preferences, protective provisions, information rights, pro-rata)
- Venture capitalists typically negotiate their rights and control. Starting at Series A, the lead investor typically gets a board seat and, subsequently, after that, for each round.
Why it matters:
Typically, since they are investing small amounts of capital, angel investors get no rights or control. Venture capitalists will expect some level of rights and control depending on what round and how much they invest. While many founders focus on valuation and dilution, the rights and control pieces are equally important since they can have long-term implications on your ability to run your business however you want.
Venture capitalists typically ask for board seats as a condition for their investment, starting at Series A and every subsequent round. This gives them a seat at the table and, more importantly, one vote for every critical company decision, such as the hiring and firing of directors, approvals for future financing rounds, approvals for the sale of the company, and more. As a general rule of thumb, you want to give up board seats sparingly and only to people you deeply trust to have the company’s best interest in mind. There have been several high-profile board conflicts in recent years at startups, such as when Uber’s board fired Travis Kalanick and OpenAI briefly fired Sam Altman.
Venture capitalists typically negotiate liquidation preferences to cap their downside. Standard liquidation preferences are a 1x multiple and standard priority stack. Investors with a 1x multiple get their entire investment back before others lower in the priority stack receive their payouts. A standard priority stack means liquidation preferences are paid out in order from the most recent investors to the earliest investor. So, an investor in your Series D round would get paid out before any of your Series C investors.
Venture capitalists typically negotiate protective provisions to veto or block specific corporate actions that may impact their ownership or future return potential, such as changing the amount of authorized common or preferred stock.
Venture capitalists typically include some form of information rights when they invest. This requires a startup to provide the venture capital firm with specific information when requested. It’s best practice for startups to update investors regularly as they want to help you and your business succeed.
Venture capitalists typically negotiate pro-rata, which allows them to invest in future financing rounds to maintain their initial percentage in the company. For example, if they secured a 10% ownership in your company at Series A, a venture capital firm with pro-rata can invest on the new terms for your Series B to maintain the 10% ownership. This is very important for venture capital firms because it prevents them from too much dilution and allows them to maintain ownership targets in their winners.
In Closing
Now that you understand the differences between angel investors and venture capital, you can decide which route is best for your business.
Additional resources:
- Angel Investor Database - to help you find angel investors
- Venture Capital Database - to help you find venture capitalists
Thanks for reading!
