Both venture capital (VC) and angel investors play an important role in the financing of smaller businesses by providing not only capital, but experience, advice, support and connections as well.
Venture Capital & Angel Investors
VCs invest money in early-stage businesses in return for an equity stake in the company, most commonly in the form of new shares.
VCs raise and pool capital from institutions, such as pension funds, and ultra-High Net Worth individuals, who are known as Limited Partners (LPs). The VCs will then charge fees on this capital, including both management fees (1-2.5% of funds under management, per annum) and success fees, also known as ‘carried interest’ (typically 20% of fund profits). VCs are very selective in who is able to invest in their funds.
The stage of development at which a particular VC invests will vary, but can begin at seed stage through to the later stages of the ‘growth’ phase, depending on the specialisation of the investment firm and the size of its fund. Companies that are looking to raise capital from VCs will often be too small to list on the public markets or secure bank debt as an alternative.
When a VC invests, it will look to hold a company in its portfolio for three to seven years and because it has been willing to invest in a business when it is at early-stage, and thereby take on more risk with the investment, it will also look for a higher return on exit relative to the investors that back later-stage businesses.
In return for this increased level of risk, a VC will also look to take a significant (minority or majority) stake in a business, and exert influence over company decision-making, with, for example, a board seat. Certain other shareholder rights are also attached to a VC investment, such as access to information and the ability to maintain the same percentage holding by investing in future financings.
The advantages for a company accepting a VC investor, aside from the cash investment to grow the business, are the business knowledge and experience that a VC can bring, along with a strong network of connections. These benefits are often one of the key reasons a business will look to access a particular VC. Furthermore, a VC investor will almost always plan for a follow-on investment in a business after it has made the initial investment, giving the management confidence that if it performs well and achieves its goals, it will get the sufficient backing needed during its early growth stage.
An angel investor will use his or her own personal funds to make an investment in a business in exchange for an equity stake. There is no set definition of what an angel investor is, but according to the UK Business Angels Association (UKBAA) it could broadly be described as an individual who is willing to invest between £5,000 and £150,000 in a single venture.
Angels invest in companies either on their own or as part of a larger group, known as a syndicate. As an angel is a private individual, they will tend to invest a smaller sum than a VC or other institution, but will often look to actively support the business either through offering advice or sometimes taking a board seat if they have requisite experience and knowledge in the company’s sector and market.
Angel investors will usually invest in businesses at a very early stage, but this is very much dependent on the individual and their own disposable wealth. It makes up the first rounds of ‘external’ (i.e. not management) investment in a business. These investors therefore fulfil an important role by backing very early-stage companies that may not be considered by a VC for investment, although the two types of investor will overlap in many cases as the company grows.
An angel will typically make a return on their investment when there is a ‘liquidity’ event, such as a sale of the business or an IPO, or the investee company is able to start paying out dividends to shareholders. This means they must be prepared to have their investment tied up for a number of years.