One of the biggest decisions a startup will make is where to seek funding. There are many options: for example, bootstrapping, grants, crowdsourcing, loans, and outside investor capital. Each source of funding can be better suited for some types of startups than others, or for specific stages of a startup. Two popular funding sources are angel investors and venture capitalists.

When startups are deciding which type of funding to pursue, it’s important for them to understand the differences and similarities between angel investors and venture capitalists. Below, we’ll discuss what angel investors and venture capitalists are, what types of startups each tends to work with, how they compare, and what startups should consider when deciding whether to work with them.

What’s in this article?

• What are angel investors?
  
• What types of startups do angel investors work with?
  
• What are venture capitalists?
  
• What types of startups do venture capitalists work with?
  
• Angel investors vs. venture capitalists: Differences and similarities
  
• Legal and financial considerations of angel investments vs. venture capital
  
• Long-term implications of angel investments vs. venture capital
  
• How to choose the right type of investor for your startup
  

What are angel investors?

Angel investors are affluent individuals who provide capital for startup companies, typically in exchange for ownership equity or convertible debt. Their typical background often includes successful entrepreneurs or retired business executives, and they possess a wealth of experience and a high net worth.

Angel investors usually engage in early-stage investments, often during the seed or startup phase of a company, where traditional financing options are limited. The scale of their investment can range from a few thousand to several million dollars, depending on the investor’s resources and the business’s needs.

Advantages

• Mentorship and experience: Angel investors often have valuable industry experience, providing strategic advice and mentorship to the entrepreneurs they back. This guidance can be important for early-stage companies navigating the ins and outs of the business world.

• Flexibility: Compared to traditional venture capital firms, angel investors typically have a more flexible investment approach. Decisions are often based on personal interest and belief in the entrepreneur’s vision, allowing for more adaptable investment terms.

Limitations

• Funding amounts: The capital provided by angel investors is generally lower than what venture capital firms can offer. This limitation can be a constraint for businesses with high capital requirements or those looking to scale quickly.

• Resources and networks: While angel investors often have substantial experience and networks, they might not have the same level of resources or connections as larger venture capital firms. This could limit the startup’s growth and networking opportunities.

What types of startups do angel investors work with?

Angel investors can be a good fit for many kinds of startups, but they typically work with early-stage companies. Angel investor groups invested approximately $950 million across more than 1,000 companies in 2021, representing a 15% increase in investment per group from 2020. Here’s an overview of the traits of different startup types they most often work with:

• Early stage: Angel investors typically fund early-stage startups, providing initial seed money to allow the team to build the business and/or product.

• High growth potential: A realistic yet ambitious plan for revenue growth shows angel investors the company understands the business’s financials and plans to grow as much as possible.

• Market opportunity: Angel investors are seeking opportunities with potential for high returns. This typically means a startup needs to address a major market demand and have a plan for capturing a large portion of that market.

• Early traction: Startups that have seen signs of early traction are attractive to angel investors. This could include strategic partnerships or a promising beta product.

• Skilled management team: A skilled and driven founder and management team is important. Angel investors want to know that the team can execute its business plans.

• Path to profitability: A business plan that includes how the startup will eventually become profitable can be attractive to angel investors.

• Exit strategy: Angel investors appreciate a clear exit strategy (in the form of a public offering or acquisition) since an exit is how they’ll eventually get a return on their investment.

• Investment focus match: Some angel investors focus on specific industries, such as sustainability or artificial intelligence (AI), and only fund startups that align with their interests.

What are venture capitalists?

Venture capitalists (VCs) are professional investment firms that provide capital to companies with high growth potential, usually in exchange for equity shares. Venture capital firms pool funds from various sources, such as pension funds, corporations, wealthy individuals, and endowments. These firms are typically managed by a team of professionals with expertise in identifying promising startups, conducting due diligence, and providing strategic guidance to their investments.

Venture capitalists typically invest in businesses that are beyond the initial startup phase, often during the Series A and beyond stages of funding. These firms are interested in companies that have already demonstrated some level of business viability or have a strong growth potential. Investments from venture capitalists are significantly larger than those from angel investors, generally ranging from a few million to tens of millions of dollars—and sometimes even more.

Advantages

• Larger sums of money: Venture capitalists can provide substantial funding, which is useful for companies that are growing rapidly. This financial backing can support significant product development, market expansion, and team growth.

• Extensive resources and networks: Venture capital firms also bring their extensive networks, industry connections, and expertise. They can assist with recruiting key employees, forging strategic partnerships, and providing access to further capital.

Limitations

• More stringent requirements: Venture capitalists have more rigorous due diligence processes and investment criteria. Companies seeking venture capital must demonstrate a strong potential for high returns, a scalable business model, and a robust management team.

• Potential loss of control: In exchange for their significant investment, venture capitalists often require a substantial equity stake and sometimes a position on the company’s board of directors. This can lead to a loss of control for the original founders, as venture capitalists may influence major business decisions.

What types of startups do venture capitalists work with?

The venture capitalist sector is large and diverse. Global venture capital investment rose from $347 billion in 2020 to a record $671 billion across more than 38,600 deals in 2021. Each venture fund has its own area of focus. This might be defined by the stage of the startups it invests in, the sector or market it operates in, or who its founders are. Regardless of these variations in preference, here are some general traits of the startups that venture capitalists most often work with:

• Innovative business model or technology: Startups offering disruptive solutions, groundbreaking technology, or innovative business models are highly sought after. These companies often address unmet needs in the market or revolutionize existing ways of doing business.

• Scalable product or service: The potential for scalability is important. VCs look for startups that can grow their operations and revenue significantly without a corresponding increase in costs.

• Strong market potential: Startups that operate in large or rapidly growing markets are attractive to venture capitalists. A large market offers the potential for substantial returns on investment.

• Competitive advantage: Companies that have a clear competitive advantage—such as proprietary technology, patents, or unique business partnerships—are appealing. This advantage should provide a barrier to entry for competitors.

• Experienced and skilled management team: A strong, experienced, and committed management team is often a key factor. Venture capitalists invest in teams that have a mix of industry expertise, entrepreneurial experience, and a track record of success.

• Evidence of traction: Startups that have shown some level of traction—such as a growing customer base, significant revenue growth, or successful pilot projects—are more likely to attract VC interest.

• Clear path to profitability: While immediate profitability is not always required, there should be a clear and feasible plan for achieving profitability in the future.

• Potential for high returns: Venture capitalists seek investments that offer the potential for high returns, often looking for opportunities that can yield several times their initial investment.

• Exit strategy: A clearly defined exit strategy—such as a public offering or acquisition—is important for VCs, as it outlines how they will eventually realize a return on their investment.

• Alignment with investment focus: Many VCs have specific themes or sectors they focus on, such as health care, technology, clean energy, or early-stage investments. Startups that align well with these investment areas are more likely to be funded.

Angel investors vs. venture capitalists: Differences and similarities

Both angel investors and venture capitalists share a common goal of investing in high-potential startups to earn a return on their investment. Both are willing to take risks on new ventures and provide advice, expertise, and network connections. They play important roles at different stages in the growth of a startup, contributing to the development of innovative businesses and technologies. Here’s an overview of their distinctions and similarities.

Size and timing of investments

• Angel investors: Angel investors typically provide capital in the early stages of a startup, often during the seed phase or at the concept stage. The amount of investment is usually smaller, ranging from a few thousand to a few million dollars. They often fill the gap between the initial funding from friends and family and larger venture capital investments.

• Venture capitalists: Venture capitalists tend to invest in later stages, such as Series A and beyond, when a startup has demonstrated some market traction or viability. The investment amounts are significantly larger, often ranging from several million to tens of millions of dollars. This reflects the larger capital base of venture capital firms and their focus on scaling businesses with established potential.

How investment decisions are made

• Angel investors: Their decision-making is often more personal and subjective. Angel investors may rely heavily on their personal judgment, the entrepreneur’s passion and vision, and the potential of the idea itself. Their processes are typically less formal, and decisions are often made more quickly.

• Venture capitalists: Venture capital firms usually have a more structured, rigorous decision-making process. This involves detailed due diligence, market analysis, assessment of the business model, and a determination of the startup’s growth potential. Decisions are made by a team or committee, rather than an individual.

Operational involvement and mentoring

• Angel investors: They often take a more hands-on approach in the businesses they invest in, providing guidance and mentorship, and using their experience and networks to assist the startup. Their involvement is usually more personal and can be key in the early stages of a business.

• Venture capitalists: While also involved in the businesses they invest in, venture capitalists may not be as hands-on as angel investors. Their involvement is often through strategic advice and using their extensive networks for business growth, partnerships, and further funding. They may also seek board positions, influencing major strategic decisions.

Legal and financial considerations of angel investments vs. venture capital

Accepting outside investment from any source often brings legal and financial considerations. Here’s what you should know:

Understanding equity and dilution

When a startup accepts funding from angel investors or venture capitalists, it typically issues shares to these investors, leading to equity dilution. This means the percentage of ownership for existing shareholders is reduced. The impact of this dilution varies significantly between angel investments and venture capital:

• Angel investments: Since angel investors often come in early, the equity they receive can be quite significant relative to the amount invested, due to the higher risk associated with early-stage startups. Founders should be mindful of how much equity they give away in early rounds to avoid excessive dilution in later financing rounds.

• Venture capital: VC firms usually invest larger amounts and might demand a substantial equity stake. But given they often get involved at a later stage, when the company’s valuation is higher, the relative dilution per dollar invested can be lower compared to angel investments. Still, successive funding rounds with VCs can lead to significant founder dilution.

Startups need to carefully plan their equity structure and understand how each investment round affects their overall ownership and control.

Preparing for due diligence

Both angel investors and venture capitalists conduct due diligence before finalizing an investment, but the depth and scope can vary:

• Angel investors: The due diligence process for angel investors is typically less rigorous than that of venture capitalists. It may focus on the founder’s background, the business idea’s potential, and basic financial health. But angel investors still require legal and financial documents to be in order, including incorporation papers, patents or intellectual property documentation, and basic financial records.

• Venture capital: VC due diligence is more comprehensive and formal. It includes a thorough review of the company’s business model, market potential, competitive landscape, financial projections, legal structures, and governance. This process often involves legal teams and financial auditors. Startups need to be prepared with detailed business plans, audited financial statements, detailed market analysis, proof of intellectual property ownership, customer contracts, and an outline of the management team’s background.

Considering other legal and financial preparations

There are additional legal and financial preparations for receiving investments, and they involve several key aspects:

• Cap table management: Maintaining an accurate capitalization table is important. It outlines all equity ownership, convertible securities, and options. This clarity is necessary for current and future financing rounds.

• Corporate governance: Establishing solid corporate governance practices early is important. This includes setting up a board of directors, defining roles and responsibilities, and ensuring compliance with regulatory requirements.

• Investment agreements: Startups must carefully negotiate and review term sheets, shareholder agreements, and other legal documents that dictate the terms of the investment. These terms include valuation, governance rights, liquidation preferences, antidilution provisions, and exit scenarios.

• Employment agreements and stock options: Create clear employment agreements—especially for key personnel—and a well-defined stock option plan for employees, as investors often scrutinize these during due diligence.

Long-term implications of angel investments vs. venture capital

Even in the early days of a startup, funding choices can have consequences years into the future of the startup. Here are some of the impacts that you should be aware of before accepting anyone’s investment:

Growth trajectory and future funding rounds

• Initial funding impact
  The type and source of initial funding can significantly influence a startup’s growth trajectory and attractiveness in future funding rounds. Angel investments, since they are typically smaller and occur earlier, might align better with early-stage startups that are focusing on proving concepts or early product development. Venture capital, on the other hand, is more substantial and usually targets startups ready to scale operations and market reach.

• Future funding opportunities
  Angel investments might be a positive signal for future investors, as they indicate early confidence in the startup’s potential. However, a startup primarily funded by angel investors might need to demonstrate significant progress to attract venture capital later, as VCs usually look for more established operations and market validation. Securing venture capital early on can open doors to additional high-profile venture investors, but it sets a high bar for growth and performance.

Exit strategies and investor expectations

• Different exit scenario expectations
  Angel investors and venture capitalists have different expectations regarding exit strategies. Angel investors might be more patient regarding the timeline and nature of the exit, as their investment amounts are usually smaller. They might be satisfied with modest returns over a longer period. Venture capitalists, with larger sums invested and accountability to their own investors, typically seek higher returns. They may push for a specific type of exit, such as an initial public offering (IPO) or acquisition, within a certain time frame.

• Implications of exit strategies
  The chosen exit strategy has significant implications for the startup. An IPO might bring in substantial funds and public recognition, but it also comes with increased scrutiny and regulatory compliance. A strategic acquisition might provide immediate and substantial returns to investors, but it could also mean loss of independence for the startup. Venture capitalists, especially those with board positions, might steer startups toward more aggressive exit strategies.

• Alignment of investor expectations with business goals
  Startups need to align investor expectations with their long-term business goals. Choosing the right investors—those whose exit timeline and strategy expectations match the startup’s vision—can be as important as the amount of money they bring.

How to choose the right type of investor for your startup

With all of this in mind, here’s how to decide which type of investor is best suited to working with your startup:

Assessment of your startup’s stage and needs

• Understand your business stage
  The first step is to gain a clear understanding of the stage your startup is currently in. Is it at the idea or concept stage, where risk is high and the business model is not yet proven? Or is it at a more advanced stage, with a working product and some market validation? Angel investors are typically a better fit for the earliest stages, while venture capitalists come in at later stages where the focus shifts to scaling the business.

• Identify support and capital needs
  Consider the type and amount of support and capital your startup requires. If you need a smaller capital infusion and value mentorship and industry connections, angel investors might be the right choice. For larger capital needs, structured growth, and market expansion, venture capital is more appropriate. Consider your runway—how long the capital should last—and which milestones you expect to achieve within that period of time.

Compatibility with investor’s expectations

• Align with investor goals
  Different investors have different goals. Angel investors may support an industry they are passionate about and may be satisfied with moderate returns over a longer period. However, venture capitalists have their own investors to answer to and typically seek higher returns over a shorter period. Understand these goals and ensure they align with your startup’s vision and timeline.

• Determine the right involvement level
  The level of mentorship you need from an investor is another important factor. If you need hands-on guidance, an angel investor who is willing to provide mentorship and has the time to commit may be more beneficial. While venture capitalists offer valuable networks and expertise, they might not provide the same level of personal mentorship—but they can offer strategic and business model guidance.

• Consider the long-term partnership
  Consider the long-term implications of partnering with an investor. Can they provide follow-on funding? Do their exit strategy expectations align with yours? How will their involvement shape the culture and decision-making in your startup? It’s never exclusively about the money when working with investors—it’s about building a partnership that can sustain and support your business’s growth over time.