Most entrepreneurs are aware that securing investments in their companies could be essential to the short-term growth and long-term success of their venture. It can often be confusing to know which investment type might work best for an entrepreneur and business. The question of venture capitalist versus angel investor often arises.

Venture capital and angel investments offer excellent options to startup businesses. Outside of choices like securing a bank loan or public offerings, these two investment possibilities are common alternatives for businesses in need of funding. While the two options are similar in many ways, they differ in a few key areas. Understanding the differences is vital to making the right choice.

Venture capitalists are primarily members of firms. Investment firms are staffed with analysts, partners, and others to ensure deals are soundly vetted. Securing funding from them can be a long process. So, it’s important for entrepreneurs to do their research to determine which firms best align with their needs. Most venture capital firms focus on targeted sectors of the business world, such as software, or on a specific geographical area when entertaining possible investments.

An entrepreneur can expect venture capitalists to do a lot of research into possible investments because they have a responsibility to their firm. Their capital doesn’t come from their own pockets. Instead, they get their money from individuals, corporations, and foundations. This means they are often using the capital of others to make investments, and oftentimes, invest millions of dollars into companies with proven potential.

Venture capitalists act as limited partners, providing help to build successful companies in a market they have deemed has potential. They are less likely than angel investors to provide capital to companies that don’t have at least some proven success in their markets. Venture capitalists usually participate in a round of investment referred to as Series A. When a company is targeted for Series A investment, it usually has a track record of sales or steady customer interest already.

An angel investor, sometimes called a business angel, usually works alone and are the first investors in a business. They’re often established, wealthy individuals looking to provide money as capital to a business they believe has potential. The companies they invest in are at an early phase in their lifecycle and looking for initial investments in their venture. This is commonly referred to as the seed round. Another Forbes article points out that at this stage of the business lifecycle, the business may simply be an idea or a prototype.

A business angel gives an entrepreneur money in exchange for a percentage of equity in his or her business. According to Entrepreneur, most angel investors must meet the Securities Exchange Commission’s definition of an accredited investor, which means they have a net worth of $1,000,000 or more and make at least $200,000 dollars a year.

Angel investors are involved at varying degrees when it comes to the day-to-day operations of the organization. Angel investors often don’t do as much initial company research and valuation as a venture capitalist firm does since they are investing their own money and don’t answer to other members of a firm or their own investors.

The level of involvement of an angel investor is different than that of a venture capitalist. They are primarily there to offer the financial support to get a business off the ground. While some simply provide the investment and hope for a return, others do become interested in the day-to-day operations of the business, especially if they have expertise in the area. Still, they are not obligated to be involved so support and mentorship may vary between investors depending on their portfolios. A popular angel investor is Mark Cuban who, according to a contributed piece in Forbes, had 110 investments in 2018.

To sum up, angel investors offer a lump sum of money in exchange for equity, usually before a company proves itself in the market. While angel investors often offer less of an investment than venture capitalists, they are not as involved in the direction of the business, leaving that to the founders.

If You Know Nothing About Venture Capital, Watch This First | Forbes

What do VCs do?

In general, the activities of a VC firm incorporate the following:

What is a venture capitalist?

A venture capitalist (VC) is a person or a company that provides funds for startup companies that show high growth potential in return for equity shares. In most cases, venture capitalists grow their funds through Limited Partners (LPs), for instance, insurance companies, pension funds, foundations and wealthy individuals. Although all limited partners have part ownership over the fund, it is the VC firm that finds new investment opportunities and makes the decisions.

VCs typically search for startups that offer a unique product or service that has the potential to draw a large audience, as well as knowledgeable and effective management teams. As VCs tend to make large investments in companies to earn higher returns, they typically invest within industries they are familiar and comfortable with. Industries that are currently exhibiting the highest growth potential are in the fields of technology and healthcare. However, VCs are also investing in other industries like retail, education and hospitality.

How do venture capitalists make money?

VC investments are high risk because firms typically invest in startup companies that are facing challenges in securing the necessary startup capital due to a high-risk profile or a lack of cash flow. Even though VCs only invest in startups that show promise, there are always risks and uncertainties involved when it comes to unestablished businesses. Also, because venture capital is a form of financing that aims for higher returns than other entities like the stock market, firms tend to make large investments.

Although VCs may experience high failure rates, they also earn massive returns on investments if startups do succeed. However, to mitigate risk, VCs rarely invest all of their money in one company. Instead, they tend to spread their investments across multiple startups, with the expectation that most companies may fail but that one or two startups will succeed. In a high-risk environment, the profits are such that a few successes are more than enough to offset failure.

Positions within a venture capitalist firm

Although the roles within VC firms may differ, there are generally four types of venture capitalist positions:

1. Analyst

Analysts are typically individuals who have just completed their undergraduate degrees. As such, this job can be a valuable training experience. The job mainly involves researching industries and supporting associates with due diligence and internal processes. Analysts may also attend conferences and do scout work for the VC firm. Typically, analysts gain experience and then move on to complete their MBAs or join another firm as an associate. Although analysts can move vertically within a firm, it is not common.

2. Associate

Associates typically have some entry-level experience in a related industry such as investment banking, product management or business development. The primary duties of junior associates include sourcing the best startups and sharing updates with principals and partners; analyzing business models and industry trends; and supporting companies in the firms portfolio. To earn a promotion to senior associate level, a junior associate would typically need to earn an MBA and work for three to four years.

The role of the senior associate, or post-MBA associate, is a coveted position. The duties of the senior associate are similar to those of the junior associate, except that the former also acts as a firm representative and has more influence with principals and partners. Senior associates often act as apprentices under the guidance of principals and partners. Senior associates need to prove that they can recognize profitable startups. If a senior associate does not get promoted, they often leave the company.

3. Principal

Principals are partners in training. Typically, candidates need an MBA and at least three to five years of industry experience. Those who do not hold an MBA probably need around seven to 10 years of experience. Although VC firms tend to often promote senior associates into this role, industry professionals with many years of experience in fields like business development or sales may also assume this position. To become a partner, a candidate needs to prove that they can increase the companys profits.

Although principals are the most senior members of staff that are directly involved with the execution of deals and negotiation processes, they also become more involved with existing portfolio companies. To execute their duties well, these professionals need knowledge of both the technologies of the industry, as well as the business and finance side of things. As senior members of staff, they sit on boards but they do not make final investment decisions.

4. Partner

As is the case with associates, VC firms distinguish between junior, senior and general levels of partners. Principals often move vertically within a VC firm into the role of junior partner, but, at times, VC firms will recruit industry executives and successful entrepreneurs. The trajectory from junior to senior partner roles often increases from deal execution towards supporting portfolio companies and LPs. As such, junior partners are still involved with deal execution but their focus shifts to working directly with startups.

General partners either have extensive VC experience or are highly successful entrepreneurs or executives. These professionals do not get involved in sourcing or deal executions. Instead, they focus on honing relationships with LPs, acting as a firms representative by speaking at conferences, serving on boards and making final decisions concerning investments. General partners also invest sizable amounts of their own capital in a fund, which means that they could potentially multiply their worth—or lose a lot of money—depending on their firms performance.

FAQ

How do venture capitalists make money?

The venture capitalist’s goal is a high (30-40 percent per year) return on the investment over the period of his or her involvement, which is typically four to seven years. This means that the company must follow an aggressive growth strategy.

What is an example of a venture capitalist?

Venture capital (VC) investments are made through a fund that is created and managed by a VC investment firm, referred to in the industry as the general partner (GP). Each fund typically has a lifespan of 8 to 12 years in which to enter into and exit from all of its investments.

What do venture capitalists do?

The Five Stages of VC Funding Explained
  • Stage 1: Seed capital.
  • Stage 2: Startup capital. This stage is similar to the seed stage. …
  • Stage 3: Early stage/first stage/second stage capital. …
  • Stage 4: Expansion stage/second stage/third stage capital. …
  • Stage 5: Mezzanine/bridge/pre-public stage.

Can you get rich as a venture capitalist?

VCs make money in two ways. Venture capitalists make money in two ways. The first is a management fee for managing the firm’s capital. The second is carried interest on the fund’s return on investment, generally referred to as the “carry.”

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