As described in our previous article, capital is the money that a business uses to keep running. Without enough capital, businesses cannot buy raw materials, pay their employees, or advertise their products. So where can a business get capital from?
At its most basic level capital is available in two forms. Firstly capital in exchange for a stake in the business itself – this money is called equity capital and secondly debt capital if the business is able to borrow from a debt provider such as a bank or finance company.
For start-ups and growing ‘SMEs’ (Small to Medium sized Enterprises) two common sources of equity capital are Angel Investors and Venture Capitalists (‘VCs’).
What is an Angel Investor?
An Angel Investor is someone with a high net worth who is willing to invest in entrepreneurs and start-up businesses.
An Angel Investor typically contributes between $10,000 – $500,000 to a start-up company. Often there is no set time frame by which an Angel Investor expects returns. They usually expect to stick with the business until it is either bought out or sold.
As Angel Investors often use their own money to invest in these companies, they do so knowing they are incurring high risks. Because of this high level of risk Angel Investor look for a high return, invest across a range of companies and know that a number will fail or provide no return.
Angel Investors can be approached either through Angel Networks (e.g. Ice Angels) or simply through crowdfunding platforms(such as Crowdsphere and PledgeMe) or via friends. Alternatively, Angel Investors often have close relationships with business incubators (e.g. Lightning Lab) and investment banks.
Why pursue an Angel Investor?
From an entrepreneur’s or business’ perspective, there are strong arguments for obtaining finance from an Angel Investor.
Angel Investors can bring a lot to the table
Often Angel Investors are successful businesspeople that have valuable skills, knowledge, networks and experience. They therefore offer the business more than just money. A business can benefit immensely from capitalising on their mentorship, expertise and advice.
It can be less risky
Personal assets (such as an individual’s property) are not used as security for a loan. Furthermore, if the business fails, the capital which the Angel Investor has invested does not need to be paid back.
What’s the catch?
An owner of the business bringing on an Angel Investor must be open to the idea of losing ownership and a degree of control of said business. In return for their investment, Angel Investors usually seek a seat at the board table.
Each individual and investment is different. Most Angel Investors like to have a say in how the business is managed and run. Some however could prefer a more laissez-faire approach.
Furthermore, the Angel investors gets a share of the profits of the business and if the business were to be sold, an Angel Investor will also be entitled to their share of the sale proceeds.
What is a Venture Capitalist?
A venture capitalist (VC) is a person, fund or company that provides finance to a business, usually to support their maturity or expansion.
VCs typically invest between $1 – 10million in growing businesses that on the cusp of generating or have started to generate revenue. In return for their investment, they usually receive a share holding of the business although VC capital may be introduced as some form of loan such as a capital note.
VC fundraise and pool together capital from different sources such as pensions, large corporations, insurance companies and endowments often through a limited partnership. The VCs then find viable investment opportunities to invest this capital into. Their end goal is to provide for their investors/sources high rates of return.
VCs usually seek a return within 5–10 years. This is normally achieved either by a sale of the entire business or selling their shareholding.
Commonalities with Angel Investors:
VCs, like Angel Investors, also face the significant risk and uncertainty that comes from investing in businesses that are in their early stages of development. Both are looking for significant capital growth of their investment.
Why choose Venture Capitalists?
VCs are also able to provide larger investment amounts than Angel Investors are willing to and usually only invest at a later stage then Angels.
What’s the catch?
As a return for their investment, VCs require equity in the business – i.e. a form of ownership. For the entrepreneur the question is how much of the ownership of the business are they prepared to give up for the capital provided. This is called dilution.
VCs will typically require that the business has good governance and will place a representative on the board. The greater the investment in the business, the bigger percentage of the business the VC will own and the more say a VC firm will look for in the direction of the company.
If you’re interested in investing in start-up businesses, please get in touch!
If you’re unsure where to get capital for your business, make sure to discuss your options with your business advisor.