Contrary to what you are seeing in the press there is excess capital and too few investment opportunities. A large amount of high net worth individuals in the West are seeking to diversify their portfolios away from traditional investments as a hedge against stock market volatility and historically low interest rates. In times of recession, the two best investment classes that have outperformed traditional markets have been commodities and private equity. So if there is so much capital available in the world today, why is it so difficult to locate the capital you need?
The most likely answer to your question is that the amounts of capital you are seeking to raise for your start-up is too small for Venture Capitalists. If a Venture Capitalist has tens of millions of dollars to invest into private equity, why would they invest in 100 or 200 start-ups? The oversight would make this an impractical avenue.
The Hunt – Venture Capitalists vs Angel Investors
Venture Capital firms are one way to raise serious amount of capital but there are pitfalls. The main one being a loss of equity beyond the 51% mark. Furthermore, the final vote on ‘the right of sale’ will also be a mandatory right for them. Since Venture Capitalists’ main motivation is ‘ROISAP’ (return on investment soon as possible), their priority is exiting as soon as possible. They will not care where that return comes from, as long as they are able to receive a bonus for the risk and skill that they have invested.
More appealing to an entrepreneur starting-up is to seek out a business angel investor that has expertise in your industry. They will either take an equity position and some level of debt (or typically a combination of the two) in exchange for their investment. They will also take a seat on your board of directors, which they will use as a platform to monitor their investment and to provide invaluable advice and mentoring. Sometimes they can actually take an active role in the organisation and pursue the optimal strategy for growth. Raising investment from an experienced angel investor will quickly allow a business to hire key employees and give the business the direction to develop and commercialise its business model.
Other benefits to the entrepreneur include access to the business networks that the angel investors may be privy to. In addition to this, there is a growing trend of angel investor syndicating; where a group of angel investors band together to fund larger investment. This means that an entrepreneur can raise significant capital (above the $500k mark) in a single financing deal without the need to negotiate separately with each investor.
Seeking to raise capital investment from Venture Capitalists may seem ideal from a distance, but if you are an entrepreneur with a long-term vision for your product then Venture Capital may not be for for you, unless you have had traction with your product or service in the marketplace. For example, Dyson vacuum cleaners before they had turned a real profit – would the product have been developed with the same love and attention to detail if they had chosen Venture Capital at its inception?
If you are seeking to build a business and your main goal is a future exit strategy like an IPO or trade buy-out then seeking out Venture Capitalists can be an extremely effective strategy. Just do bear in mind that many entrepreneurs from the start, have been squeezed out long before ‘D-Day’.
Angel investment therefore represents an invaluable source of alternative funding. One that is far more attractive and realistic for a start-up entrepreneur that is looking to build a business and stick with it for the longer term. Benefits for both the entrepreneur and the angel investor can be great provided of course that the expectations are well drafted and the funding agreement is structured to meet the demands of both sides.
The main difference between a business angel and a venture capitalist is that venture capital funding will come with legal agreements that will inevitably always be Venture Capitalist biased, whereas angel investment will be far more flexible and tailored to both sides. It’s not uncommon for some angels to even shy away from using corporate solicitors when drafting agreements for funding. The reason simply being that if a high net worth individual chose to invest in 8 – 10 companies, the total legal bill could turn out to be over $50,000 (assuming a lean estimation of $5k per company).
Raising venture capital funding will not only provide you with the necessary structured investment but will also bring you a wealth of managerial talent and experience but not mentor-ship that most entrepreneurs will crave during the early stages of their start-up. However, the professional advice may well bring the competitive edge to most businesses and a Venture Capitalist’s network of contacts could make the difference in a successful exit via an IPO or Trade Sale. However, always remember that being funded by a Venture Capitalist will mean that regardless of whether or not they actually hold a controlling interest in your company, they will be in control of your organisation and control how the company is run. This may be in conflict with your ideal vision.
….So better with an Angel Investment? Or Venture Capital?
More often than not, it’s best for an entrepreneur to start up on their own or with the help of an angel investor (or syndicate if the investment requirement is too large to be funded by one individual). After running and evolving the business, the next best course of action is turn to Venture Capitalists when you believe you are ready to take your company to the next level. Before even considering approaching a Venture Capitalist, you will have to demonstrate that you have a degree of success in your past, which is where the first round of your funding and management of your cash flow will come in handy.
When you do decide to approach Venture Capitalists and should they agree to back you, then it will be crucial to seek-out the best legal advice that you can afford for the negotiations. A single sentence in the initial contract can determine your success or failure. Venture Capitalists are consummate professionals and you will have to become one before playing their game.