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50 questions: What’s the difference between angels, VCs and strategic investors

By on January 6, 2011

The Together with Nic Brisbourne of The Equity Kicker / DFJ Esprit, I am writing a series of 50 questions you should ask when raising venture capital. We expect the series to run for a year, after which we will collate the answers into a book. We view this as a collaboration, so please comment to help make this series even more useful. This is post #8 in the series.


The world of capital raising is full of jargon. Like most jargon, terms can be useful shortcuts or a complex barrier to understanding.

Today we going to talk about the difference between angels, venture capital funds and strategic investors.

Angels

Angel investors are typically former entrepreneurs who want to support the start-up community. Unlike venture investors, they are rarely spending other people’s money. It’s all their own. This can mean that they are more cautious. On the other hand they can move quickly, can back hunches and choose to work with people they like irrespective of the product or stage of the company.

In practice, no two angels are alike. Almost by definition, each one is individual with different risk appetite, expertise and investment approach.

Angels are becoming increasingly important to the start-up ecosystem. As the costs of launching a new product and time-to-market for a new start-up continue to fall, angels are increasingly able to provide sufficient capital to allow the company to reach the first critical milestone (often called “determining the product/market fit”).

(Entrepreneur and author of Four Steps to the Epiphany Steve Blank sets out why he thinks the current decade will be the decade of the entrepreneur on his blog. The conditions which favour the entrepreneur also explain why angels are wresting control of early-stage financing away from venture capital funds.)

Finding a good angel is a matter of hard work mixed with a lot of luck. Angels are generally out looking for investments, but they do not have shiny offices, formal submission processes or junior analysts to sift through large numbers of business plans. The hard work includes following angels on their own blogs, on Twitter, at conferences, and on the range of technology or investment blogs such as Techcrunch and Venturebeat. It means networking with angels, entrepreneurs and journalists. It means putting yourself in situations where serendipity can strike.

As Nicholas Nassim Taleb, author of The Black Swan, says (I paraphrase)

“if you want to get lucky, go to parties.”

Venture capital funds

As Nic explained in his last post, venture capital funds are often, but not always, driven by the needs of their Limited Partners. This means, among other things, that they need to have a more formal investment process than angels, that they need some element of accountability, and that it is harder for them to proceed on the basis of gut feel or affinity with the management team alone.

There can be significant advantages to working with venture capital funds. Depending on the fund, they may be well connected globally. They are likely to have other companies in their portfolio who may be suitable partners, mentors, or just people to chew the fat about business issues with. They often have follow-on capital to enable the company to grow without finding new external partners. An experienced venture capitalist will have good connections with likely acquirers in your sector, paving the way for eventual exit several years down the line.

On the other hand, they may require more stringent reporting and management accounts. They may require a board seat. They may be less flexible than an angel/entrepreneur who has been there before and understands the challenges of running a start-up.

Strategic investors

Strategic investors may mean a direct investment by one corporate in your start-up or it may mean a dedicated fund owned entirely by a corporate which focuses on investments in companies which are of strategic interest to the parent. Examples include Disney’s Steamboat and GE Capital/NBC Universal’s Peacock Equity fund.

Strategics are often well funded and can often provide substantial operational benefits. However, the disadvantages need to be weighed up carefully:

  • Strategic investors may not be professional investors. They may be more interested in understanding the market that you are targeting than in helping you build a multibillion dollar business
  • Depending on their structure, the funds available may disappear abruptly if there is a change in strategy or the departure of a senior executive
  • Having a strategic investor can lead to challenges at the time of exit. If the strategic does not choose to buy you, their competitors may well think “if those guys, who know the company better than anyone else, are passing on this deal, what do they know that we don’t?”

Strategic investors can bring many advantages, but not without risks which need to be carefully evaluated.

Conclusion

No two investors are the same. Even companies or individuals who seem to be easy to categorise will have specific issues when choosing their investments. The best this post can do is provide a broad overview. All entrepreneurs need to spend the time and effort required to understand the motivations of anyone they hope to persuade to put money behind their ideas.

Hungry for more? Go to the 50 questions homepage for more insights into venture capital.

About Nicholas Lovell

Nicholas is the founder of Gamesbrief, a blog dedicated to the business of games. It aims to be informative, authoritative and above all helpful to developers grappling with business strategy. He is the author of a growing list of books about making money in the games industry and other digital media, including How to Publish a Game and Design Rules for Free-to-Play Games, and Penguin-published title The Curve: thecurveonline.com
  • http://www.theequitykicker.com brisbourne

    Hi Nicholas – nice post. A couple of thoughts:
    1) a good VC will have experience of seeing many startups grow (and maybe a few fail) and will be able to help advise. This can be particularly valuable around exit. A VC’s experience is likely to be over more companies than an angel’s.
    2) with strategics it is important for the company to make sure it is protected if divergence of even competition with the strategic investor emerges down the line. I have seen 2-3 companies lose a lot of value by getting this wrong.

  • http://www.grow-connect.com/ Angel Investor

    Great article . Eye catching to the readers . Great questions as well . Thanks for this . :D