The Funding Question: What are Angel Investors and Venture Capital Firms?

Entrepreneurs are often faced with the question of what type of investor is necessary for the stage of their business. The answer is not always simple. It depends on a number of issues including the amount of money sought, the type of business and the development stage in which the company finds itself. Knowing the differences from angel investor to angel investor and from venture capital firm to venture capital firm can save an investment-seeking entrepreneur significant amounts of time.

As a rule, angel investors are high-net-worth individuals with a history of financial success. They may or may not take an active role in the company, but generally have "other day jobs." Angels tend to fit the role of mentors for many companies, offering help when requested and sometimes when it is not requested.

A key point to remember is that angels are writing personal checks using their own funds. They usually do not require a controlling equity stake and will often invest in groups (referred to as "angel groups") or in conjunction with venture capitalist firms. There also is a national association called the Angel Capital Association (ACA) (www.angelcapitalassociation.org), which has 165 member groups with approximately 7,000 accredited investors. There are two local member groups in Kansas City; the Mid-America Angels (www.midamericaangels.com) and the Women’s Capital Connection (www.kansaswbc.com/
WomensCapitalConnection/tabid/1221/Default.aspx). Another group, the Show Me Angels, has recently been estalished in the Kansas City area, but are not yet a member of ACA (www.showmeangels.com.)

The timing of an angel investment is normally subsequent to any investment by family or friends, when the company is more than just an idea or a concept and has moved at least into the prototype if not early-sales stage. The amount invested at this stage can range from $10,000 to $1.5 million per investment.

Venture capital firms however, invest other people's money and as such are motivated to bring their investors a large profit. To obtain a sizeable return, venture capitalists only consider companies with huge growth potential and in large market segments. Generally a venture capital firm will invest in deals ranging in the multiple millions of dollars. And the venture capitalist likely will take a much more active role than that of an angel investor—a role that might include something as simple as a seat on the board or as obtrusive as day-to-day involvement or a combination of the two. A venture capitalist's investment typically involves a large piece of the company's equity, often becoming the controlling interest.

In either funding scenario investors consider a broad range of criteria when evaluating their target for investment. Criteria could include a:

• Management team that has both the domain and professional experience.
• Product or service that is solving a real "problem."
  
• Company that is in a market with which they are familiar.
  
• Large market opportunity with the ability to gain significant share.
  
• Product or service for which people will be willing to pay.
  
• Strong product or IP (intellectual property) that is ideally patentable.
  
• Business that can scale and that can have significant margins.
  
• Specific exit strategy.
  

Often it is difficult to find a single angel investor or a venture capital firm to provide $500,000 to $2 million because the deal is, respectively, either too large or too small. Sometimes after one investor type provides funding, others will follow. In the case of angels, an investment-seeking entrepreneur may not be able to locate one "superangel" to provide the amount of funding necessary. Such an entrepreneur may be able to convince a group of angels to do so. Alternatively, the funding could come through several rounds of investment requests, instead of trying to get the entire sum in one attempt. In any event be prepared to give up a portion, if not a significant amount, of equity and independence.

Regardless of the investment avenue, an entrepreneur should plan many months ahead when raising capital. It could easily take up to a year. Also be prepared for critique and rejection. Evaluate the input and, if it is valid, incorporate changes in the next presentation. Seeking capital can be a frustrating and time-consuming process, but when the right partner (angel or venture capitalist) is found it can pay off big for the entrepreneur's business through revenue growth and through the connections and expertise the right investor may bring to the enterprise.

This story was featured in the October 2008 newsletter