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Pros and cons of venture and angel investing

Brian O'Connell on November 18, 2011 Source: Kauffman Foundation

For entrepreneurs, choosing the best financing model for their early-stage startup isn’t a luxury – it’s a necessity.

Usually that means vetting several funding options, like friends and family, or a bank loan. But more likely, it means choosing between one of two primary small business funding options – venture capital or angel investors.

Which is better? To break it down, let’s examine the pros and cons of angel investing and venture capital.

Definition of Angel Investing: An angel investor invests in a new business, offering capital for startup or expansion. Angels are not usually among the so-called “1 percent;” many have annual incomes of $200,000 or less. They’re drawn to startups for a higher rate of return than they might get in the stock, bond or real estate market.

Pros

  • Angels are a good fit for many startups – typical investments are between $25,000 and $1.5 million.
  • An angel could be your neighbor. Accessibility isn’t a big issue with angel investors; most cities and larger towns have angel groups or associations. The Wall Street Journal offers a great tutorial on finding angel groups here.
  • Due diligence is usually fast, and the investment also usually comes in the form of a lump sum.

Cons

  • Angel investors expect a high rate of return – often 25 percent or more.
  • Angel investors are usually highly risk-averse, and will rarely make “follow-up” investments.
  • Depending on your “angel,” you might find yourself wrestling with your financier over key company decisions. After all, now that he or she is an investor, your angel feels entitled to some control over your company’s future.

Definition of Venture Capital: Venture capitalists invest in startup companies that offer the possibility of profit but with no guarantee the company will make one. They tend to make higher volume investments than do angel investors, and may likely take a larger consulting and management role, as well.

Pros

  • Venture capital firms have deep pockets. The average investment is usually between $500,000 and $5 million.
  • Most venture capital firms offer new startups access to knowledgeable and experienced consultants to help guide your business. Since VCs have a vested interest in your success, they’ll want you to have the best business and management help you can get.
  • They have many deep-pocketed friends who may decide to invest in your company, as well.

Cons

  • Venture capital firms expect a big return on their investment dollar – much bigger than a typical angel investor. Expected rates of return can be as high as 50 percent annually.
  • Venture investors are nothing if not diligent. Hence, they can take six months to a year before deciding to invest in your firm. Business owners who don’t possess the patience of a saint may find that wait excruciatingly frustrating.
  • They’ll ask for equity. Venture firms invest a lot of cash, and they’ll want a lot of control, as well. Often they get that by asking (and getting) a big equity stake in your firm (an angel investor is less likely to ask for that). If you give a VC firm 50 percent or 60 percent of your firm’s equity, you could lose control over your own company.

There is no pure right or wrong way to find financing for your company.

But if you choose either an angel investor or a venture capital firm, at least know what the stakes are going into the deal.

Otherwise, you might get way more than you bargained for.

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