Small Business Funding Options: Venture Capital vs. Angel Funding

Published by Mike Michalowicz (Google+)

Small Business Funding Options

The lifeblood of any small business enterprise is money. But like with any commodity, such as oil or gold, access to money has a price tag on it. There are investors who may well provide capital for your business. However, it’s not your interest they have in mind but their own.

More specifically, business investors have one question they want you to answer: What’s in it for me?

To better answer that question, business owners seeking funding have to figure out what type of capital investment they should pursue. Usually that means venture capital (VC) versus angel funding.

So far, the news on venture funding is brightening in 2012. According to PWC MoneyTree’s quarterly outlook on business funding (PDF), venture capital is up 22% from January 2011 to January 2012.

The study reports that venture capitalists invested $28.4 billion in 3,673 deals in 2011, the third highest year for VC funding in 10 years.

Tracy T. Lefteroff, global managing partner of the venture capital practice at PricewaterhouseCoopers, said:

As previously projected, venture capital investing in 2011 exceeded 2010 levels and ranks in the top three years for VC investing in the past decade. We saw a resurgence in investments in Clean Technology and Internet-specific companies in 2011, as well as a bit of a jump in average funding in the Internet sector. However, while venture capitalists continue to show their interest in these areas, they are acting prudently and not chasing excessive valuations. Accordingly, despite the increase in investing, we’re unlikely to see these sectors overheat like we saw in the 1999 to 2000 era.

For its part, angel funding is on the rise, according to a new report from Silicon Valley Bank (SVB). The study notes that median angel funding rose 40% in 2011, with the average deal around $700,000, as opposed to $500,000, SVB says.

California business owners earned the lion’s share of angel money, with 29.8% of all deals in the U.S. last year. Technology and health care firms together accounted for 58% of all angel capital, SVB says.

What’s the better deal? Here’s a point-by-point breakdown.

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%" — 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.

The Good

  • Average angel investments are between $25,000 and $1.5 million — plenty of cash for a new startup.
  • Angel investors often are local. They tend to be wealthy investors, even retirees, and might even be your next-door neighbor.
  • Angel investors tend to make up their minds quickly, get you the cash quickly (if you’re approved), and usually pay up with a lump-sum check.

The Bad

  • Angel investors want a big stake in your firm. Expect them to ask for 25% or more.
  • Angel investors don’t like risk. The more uncertainty an angel sees with your firm, the less likely he or she will make future investments.
  • Control is a big issue with angel investors. They may want more decision-making rights than most business owners are comfortable giving.

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.

The Good

  • Cash is king with venture investors — and they tend to have lots of the green stuff. The average investment is high — often between $500,000 and $5 million.
  • Besides deep pockets, venture funders have great business connections, and can hook a business owner up with good advisors, smart lawyers and accountants, and savvy sales and operational consultants. The mantra for VC’s is this: We’re all in this together.
  • Those connections can also lead to investments from friends and acquaintances. Venture investors are a close-knit group, and often recommend deals to other investors. So if you fail with one VC outfit, ask for referrals.

The Bad

  • Venture capital firms want the moon from business owners — and more than that. Entrepreneurs can anticipate VC investors demanding 50% of future profits.
  • Venture investors like to take their time. They tend to take six months or more before making a decision, and will keep business owners hopping with repeated requests for documents, paperwork, and financial analysis.
  • VC investors don’t mind asking for a piece of your company, especially if you’re cash-depleted. VC firms often demand a fat equity stake in your firm. But be careful — giving an investor 50% or more your company takes you out of the driver’s seat.

Take plenty of time deciding between an angel investor and a venture capital investor. If you have your sights set high, VC firms have more cash, but will want more control. In contrast, angel investors won’t ask for as much control of your firm, but don’t have as much money to offer, either. It all depends on what your company needs, and how close a business partnership you really want from a financial investor.

Brian O’Connell is a former Wall Street bond trader turned journalist, who’s been covering business news and trends for over 15 years. Brian’s work has been featured in dozens of renowned business publications, including the Wall Street Journal, TIME, CNBC, and Brian is a freelance small business journalist for Vistaprint, the leading online provider of marketing products and services to small businesses around the globe.

Image by Images_of_Money on Flickr

Category: Money & Equity
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  • johnPGISelfDirected

    The reason why most angel investors are less likely to make follow-on investments is because of the risk associated with losing even more money when reinvesting in an unsuccessful company.  (By the way,  I head a national marketing and financial services company dedicated to assisting clients with establishing client-controlled, self-directed IRA and 401K accounts. If you need help in that field, don’t hesitate to call me.)

    • toiletpaperentrepreneur

      Thanks, John!

  • Lee Car

    The general rule is business angels for smaller commercial funding amaounts, where for a large amount of business finance may be best fit to a venture capitalise.

  • Mac Lew

    When it comes to funding ensure the funders are looking for a good past history which
    indicates a robust future