Entrepreneurs tend to incorrectly view angel investors and venture capital firms as identical sources of capital. Although both seek sound companies in which to invest, there are differences in their approaches.
These differences exist even in this era of venture capitalists entering into deals with angel investors. Those are basically opportunities for the VCs to obtain a foothold for future funding rounds of angel deals that perform well. But seeking venture capital as a primary source entails dealing with a mindset that’s distinct from angel investors.
The partners at venture capital firms are very active on the corporate boards of the companies they finance. There is limited time for this. Therefore, VC partners have to give money only to companies with enormous upside potential. They are very picky about the opportunity for gain and have little concern about the risk of loss. Their time is too valuable to examine much about the downside.
Angel investors have a different approach. They like to know about recovery of their money even if the company in which they invest doesn’t perform well. Angel investors don’t have to find the next big thing for their capital. They are content to find a reasonable opportunity with limited risk.
This is why the companies that attract angel investment have already created a working prototype. Angel investors also want to see that a company already has some users of its product. The best entrepreneurs have customer feedback and clear concepts about product improvement and marketing. The business idea has already been validated by action. This positions the company with limited risk.
In addition, the equity a corporation gives for the money raised from investors implies a valuation for the business. This value is derived from the price per share. It’s compared to the share price of similar companies that have been acquired. Investors see limited risk if corporations within the industry are regularly acquired for much higher prices. This reflects a limitation on risk. That’s because many acquired companies simply can’t raise enough capital to reach their potential. They are essentially liquidating.
Savvy entrepreneurs don’t sell out too early. They continue building their companies. Of course, this requires expansion capital. But obtaining funding from angels doesn’t require a company with huge potential. Instead, angel investors will find appeal to a company with merely good potential that can make a case for limited risk.