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Understanding angel, venture capital funding

Many potential entrepreneurs think that if a business idea is unique, that’s enough to attract angel investors and venture capitalists.

Angel investors and venture capitalists do not just invest in a vision or ideas but a lot more than that. What gets their attention is the demand or the market size the business and/or entrepreneur has created. They look for higher sales probability because it’s an indicator of return on investment.

Companies like Apple, Google, Yahoo, Facebook, Hewlett Packard, AOL and many more — not limited to just the tech industry — were small businesses started in a garage, college dorm or in a bedroom by students, hobbyists and hardly known entrepreneurs. The businesses experienced growing pains based on the whole new market, consumer interest and demand that they had created. And that is what attracted angel and VC funding.

What’s the difference?

An angel investor is often an experienced investor or a group of professional investors that often invest their own money. Sometimes a relative, a friend or someone with interest in investing in a business is also referred to as an angel investor.

Angel investors typically invest anywhere from tens of thousands up to hundreds of thousands of dollars. There are also super angels and their investment can go up to a million.

Venture capital firms usually invest in private startup companies with a high profit potential. The venture capital investment funds come from large corporations, wealthy investors, investment corporations or subsidiaries of investment banking firms, pension funds, insurance companies and similar resources.

Angel investors see value in the equity of a company, which also means that they take a proportion of the company. They usually take a 20-40 percent stake in the companies they help build and often use a company’s valuation as a measure to decide how much company ownership they should take.

Let’s say, for instance, that the company is worth a million dollars. If angels put in $500,000, the company is now valued at $1.5 million. This means that the angels are entitled to a third of the company. If they help grow the company, then it increases their return on investment. Sometimes, when the company shows high growth potential and requires more investments, the angels bring in venture capitalists, sell their share to the venture capital firm and exit with high profits.

When venture capitalists fund a startup or a company in its early stage, they want 20 to 30 percent of the company with an expectation of high returns – sometimes 10 times the original investment.

Both angel and venture capital investing are high-risk investments.

Angel investors are less likely to become board members but they remain actively involved in a company. Venture capitalists get highly involved. They usually take a seat on the board of directors and/or bring in their own consultants or executives to help manage and grow the company.

When venture capitalists exit the company, it’s often after the company is brought into the main stream. The entrepreneur who operated under their guidance also improves tremendously and becomes capable of operating a large corporation.

In case the company fails while operating with venture capital funds and guidance, then the venture capital firm sells the company’s assets and tries to recover as much as possible.

Why are angels and VCs so selective?

High-risk investors want to know if the entrepreneur offers originality in the business idea and can proves consumer or market interest. They want to understand:

n What makes the product or service unique and sellable;

n How much money the entrepreneur has put into the business;

n Business plan with financials;

n A successful execution plan;

n Marketing strategies.

They also want assurances the executive team has problem solving expertise; has perseverance; is passionate; adaptable; focused; confident, persistent; presentable; has good communication skills; understands the risks and is willing to take advice.

If you are an entrepreneur with a successful track record in business growth and development, then it’s often your credibility that stands out to the investors.

Whether you are a beginner or experienced entrepreneur, they are investing in you.

— Raj Tumber specializes in strategic business development. He has worked with Fortune 500 companies and developed strategic business and management skills. He is also a certified business mentor with SCORE, an organization that helps small-business formation and growth. Reach him at rajtumber.com.

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