Fundraising Differences Between Angels and VCs

Having raised $50M in angel and venture capital for my startups, I am often asked to compare and contrast the two. Let’s dive into the key differences and how both investor types can support a high potential startup.

What is an Angel Investor?

Angels are high net worth individuals who invest their own capital in companies. Each angel has their own objectives, interests, and investing style. Angels may invest individually or may band together into groups. Critically, angels are responsible only to themselves and can be quite idiosyncratic in their approach to investing.

In most circumstances in the U.S., angel investors must be accredited to invest in privately held companies. If you want to raise money from angels, be sure you understand the SEC’s rules on accreditation and have an experienced attorney helping you.

To give you a feel about the variations in angel investors, let me tell you a bit about my angel fundraising experiences. I have raised about $20M in angel funding from over 100 angels in three different startups. My angel rounds have ranged in size from $750K to over $2.5M. Some investors have written checks for as little as $10K while others have invested $250K in an individual round. Some angels have individually invested over $1M over multiple rounds in a single startup and have brought along their friends to fill out a round. Some angels have invested in more than one of my startups. In my experience, angels vary significantly in what aspects of a startup they care about and what information they personally want to make their investment decision.

What is a Venture Capitalist?

Venture capitalists (VCs) are professional investors who develop an investment thesis, form an investment fund, and convince accredited investors (a.k.a. angels) and institutional investors to invest. Because the VCs raised their fund based on a declared investment strategy, they are obligated to their investors (known as limited partners or LPs) to invest in companies that fit that strategy.

In my last post, I suggested that venture capital isn’t a good fit for most startups. However, I love building venture-backed startups. I have raised about $30M from venture capitalists in Midwest and East Coast-based funds. Their funds ranged in size from small $10M funds to hundreds of millions. Their investments in any given round could range from $100K to $5M or more. All of the VCs I raised from were partnerships with an investment committee that had to approve any investment. The sponsoring partner formally proposed all investments.  

Venture Investing

Both Angel and VC investors typically take an ownership position in a high potential startup through common investment structures such as convertible notes or preferred stock.

The decision to invest early in a high potential startup is always risky.  By their very nature, startups have no-to-limited track records, often don’t have fully developed products, and have not yet confirmed product-to-market fit.  High potential startups make up for all that uncertainty by having a compelling story about how they will make an important and valuable impact in a substantial market.

It is up to the possible investor to evaluate the validity of the startup’s story and the likelihood of achieving success. In future posts, I get into the factors that influence success or failure; however, for now, let’s focus on the process investors use to evaluate and invest in a startup. 

Differences in Due Diligence and Investment Decision-Making Processes

One of the most significant differences between angel investors and VCs is their approach to due diligence and investment decision-making.  The underlying cause of this difference derives from the fact that angels are investing their own money and VCs are investing other people’s money. 

Practically, angels are only accountable to themselves. Once they feel they have enough information to make a decision, they can simply make it and invest. They are not required to convince other people that their decision to invest is a good one, nor do they have to create formal documentation justifying their decision. In my experience, they seldom hire third-parties to evaluate the startup and rely predominantly on their own judgment. However, sometimes angel groups will share due diligence and get different expertise and points of view through their joint process.  Nonetheless, even in groups, each angel ultimately makes their own call on whether to invest.

VCs, on the other hand, are accountable to their limited partners (fund investors), and they have formal processes to try to increase their chances of making wise investment decisions. With a VC, you are making a two-stage sell. First, you have to convince the lead partner and associate and, second, you have to equip them to convince their partners. Often this means producing incredible amounts of detailed analysis and submitting to inquisitions by their third-party technical consultants, lawyers, and other professionals hired (ultimately at your expense if they invest) to vet your story. The lead partner and associate build a formal case called an investment memo (which you don’t get to see) that lays out the opportunity and risks. Ultimately, the fund’s investment committee makes the investment decision.

Differences in Deal Making

How a round’s investment terms are structured and who sets the terms often depends on the startup’s stage and whether the investment round is targeting angel or VC investors. 

A lead VC who is taking a substantial part of the round (often 50% or more) of the round will insist on proposing and then negotiating the investment terms with the company. Getting to a term sheet laying out the terms of the investment can be an intense process, however, once signed, the lead investor will usually become quite helpful building out the remainder of the investor syndicate to complete the round.

Angel rounds are often assembled from many smaller investors without a clear and dominating lead investor. As a result, the company can find itself in the position of proposing a set of investment terms in hopes of persuading a sufficient number of angels to accept those terms. It might seem like this would be an easy path. However, I have witnessed situations where the angels did not like the terms and simply passed on the investment. This can easily turn into an inability to raise funds at all.

Conclusion

I feel like I could discuss the many dimensions of fundraising for days! However, I will have to tackle those in future posts, so this one doesn’t go on forever. Most importantly, remember that VCs invest other people’s money, and Angels invest their own, which results in distinct differences in the way each of them approaches the investing process.