Angel Investor and Venture Capital

An angel investor is NOT an investor with golden wings and a halo but rather an individual who provides start-up capital to a new business and expects a percentage of ownership equity in return. Angel investing is a common business practice in the United States and Europe but will often take on different names depending on the country.

In the United States, the term 'angel' derives from the early twentieth century when wealthy businessmen eagerly invested in lavish Broadway productions. Throughout Europe, an "angel investor" is known as a "business angel," a financier who provides equity capital for start-up companies and growing firms. Regardless of location, most angel investors invest their own capital, although there are some angel groups where several investors combine their capital so they can invest in more opportunities.

Unlike institutional lenders and venture capitalists, angel investors have diverse backgrounds and perspectives. In fact, their beliefs of a company's business practices and how a start-up should be managed and operated may differ significantly to what entrepreneurs may have in mind. Therefore, some angel investors can be viewed as either beneficial or detrimental to a new company's success.

Since angel investors tend to invest a large amount of personal capital in a small number of companies, their perspectives on start-ups can also be dramatically different than investors who have experience in tens and hundreds of enterprises. While it may be advantageous for a new entrepreneur to raise capital from an angel investor, the business owner should fully understand their term sheet and the ramifications associated with obtaining start-up capital from an angel investor. Entrepreneurs can develop a better understanding of the agreement from an attorney in their industry and are encouraged to look at angel investors from the following six perspectives before signing the term sheet.

1. An angel investor's value to the start-up
2. Background and perspectives
3. Differences in expectations
4. Risk of investment and patience
5. Professional management of the company
6. Ethics

Different funding opportunities exist for people who are seeking start-up capital. These funding opportunities can range from taking out a small business loan from the local bank to borrowing money from relatives and friends. Another option to obtain necessary start-up funding is through an angel investor. With several different funding opportunities available, it is important to understand the ramifications of each loan in your business pursuit.

Angel investors and equity financing
Often times, when a prospective entrepreneur exhausts all of their immediate funding sources, they turn to angel investors to raise capital. Angel investors will provide the amount of needed funding to the entrepreneur in return for equity capital. This means that the new business will be funded in exchange for ownership interest in a company. This interest usually comes in the form of stocks or some other form of ownership that converts to stock. Unlike traditional debt financing that requires immediate payment over time, equity financing does not involve repayment of the borrowed money since angel investors desire equity ownership stake.

Angel investors and their exit strategy
Before investing in a business, an angel investor will expect an exit plan, the agreeable strategy by which they will cease their ownership in a company. This can come in the form of an acquisition, initial public offering, earn-out, merger, or debt-equity swap. Angel investors who hold equity ownership in a company will often prefer to sell their shares in an IPO (or initial public offering), while others may prefer the sale or merger of the company.

Angel investors and experience
When angel investors invest in a company, they usually request a seat on the Board of Directors and/or take an active management role in running the company. This can be perceived as both good and bad. It is good in the sense that often times experienced angel investors will provide valuable insight to the entrepreneur, mentoring them throughout the venture in order to ensure the invested company's success. However, there is a downside to giving up a certain percentage of ownership to an angel investor. The more ownership that the entrepreneur gives up, the more overall control they lose.

A venture capitalist is a person who provides equity financing to companies with high growth potential. The money that a venture capitalist invests in a company is called venture capital. Venture capital firms are often limited partnerships that comprise a few venture capitalists. Each venture capital firm manages a venture fund, which is often comprised of a large pool of money--anywhere from $25 million to $1 billion--that the firm invests in growth companies. A venture capital fund consisting of third-party investments can finance enterprises that are too risky for debt financing. Each VC firm invests in several companies and this group of companies is called the firm's portfolio companies or portfolio.

Venture capitalists generate profits by providing equity financing to startups that have high growth potential. Venture capitalists buy the equity of a startup and liquidate their shares either through an IPO or through an acquisition. Given this situation, the growth potential and the risk factor of the startup critically determine the profits VCs generate. The success of a startup depends on a number of factors. Venture capitalists carefully examine each factor before they decide to fund the startup.

Venture capitalists assess the risk using the following factors:

* Founders/Management Team
* Competitive Advantage
* Market Potential
* Barriers to entry
* Exit Strategy