How to Raise Fund Using Venture Capital & Angel Investors
Learn the difference between venture capitalists, angel investors and how they can help you raise business finance. This article will show you how to raise business fund using venture capital vs angel investors.
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Most business owners can raise money or start-up capital for their businesses through a variety of financing sources. These sources are broken into two categories, debt financing and equity financing. Now, let’s get some points cleared up:
What is Deb Financing?
Deb Financing involves the borrowing money to be repaid with interest; basically, such money is borrowed to run a business. In broad sense, debt financing occurs when a firm raises money for its operations or capital expenditures by selling bonds, bills or notes to individuals and/or institutional investors.
This kind of business financing is usually possible if the company is a public Limited Liability Company (PLC) or corporation. Nonetheless, successful long-term growth for most small and medium sized businesses across the world is dependent upon the availability of equity capital. Angel investors and venture capitalists are the two most important sources of equity capital.
What is Equity Financing
Equity financing is the process of raising your business working capital through the sale of shares (ownership interest) in an enterprise to raise funds for business purposes. Equity financing is where the money raised gives the investor an ownership interest in a company.
This ownership is commonly represented in the sale of shares (stock) to a limited number of investors or participation by venture capitalists. However, a company can only sell its shares, or transfer its right of ownership to the public as a means to raise funds if its articles allow this power.
Therefore, the two key sources of equity capital for new and emerging businesses are angel investors and venture capital firms.
How to Raise Business Fund using Venture Capital Vs Angel Investors
Venture Capital and Angel Investors Defined
Venture capital for new and emerging business ventures typically comes from high net worth individuals (“angel investors”) and venture capital firms. Venture capital investors or adventure capitalists, typically provide unsecured capital to young entrepreneurs or private companies with the potential for rapid growth.
Such investment covers most industries and is appropriate for businesses going through different stages of developmental. However, this type of investing inherently carries a high degree of risk. For example, venture capital is long term or “patient capital” that allows the benefiting companies or individual founders the time to mature into profitable organisations. Venture capital is also an active rather than passive form of financing.
This is because these established investors seek to add value, in addition to capital, to the companies in which they invest – i.e. an effort to help them grow and achieve a greater return on the investment. Thus, this requires their active involvement. Almost all venture capitalists will, at a minimum, want a seat on the board of directors.
Even though these angel investors are committed to a company for the long run; that does not mean indefinitely. The primary objective of equity investors is to achieve a superior rate of return through the eventual and timely disposal of investments. Again, a good investor would be considering potential exit strategies from the time the investment is first presented and investigated.
Potential entrepreneurs and existing businesses should therefore consider this financial source carefully, because they will participate in the increased value of the business and have voting rights as well. As the business the founder or chief executive officer (CEO), your lawyer and accountant would be appropriate go-to sources for more information on this subject.
Who are Business Angels or Angel Investors?
Business “angels” are high net worth individual investors who seek high returns through private investments in start-up companies. These private investors generally are a diverse business men and women who made their wealth through a variety of sources. But the typical business angels are often former entrepreneurs or company executives who cashed out and retired early from ventures that they started and grew into successful businesses. Hence, these self-made investors share common characteristics.
Characteristics of Angel Investors:
- Angel funding seek companies with high growth potentials, strong management teams, and solid business plans to aid the angels in assessing the company’s value.
- Many seed or startups may not have a fully developed management team, but have identified key positions.
- They typically invest in businesses that involved in industries or technologies with which they are personally familiar with.
- They often co-invest with trusted friends and business associates.
- In these situations, there is usually one influential lead investor (“archangel”) whose judgment is trusted by the rest of the group of angels.
- Because of their business experience, many angels invest more than their money.
- They also seek active involvement in the business, such as consulting and mentoring the entrepreneur.
- They often take bigger risks or accept lower rewards when they are attracted to the non-financial characteristics of an entrepreneur’s proposal.
Venture Capital vs. Traditional Financing Methods
Venture capital is a type of equity financing that addresses the funding needs of entrepreneurial companies that for reasons of size, assets, and stage of development cannot seek capital from more traditional sources, such as public money markets and the commercial Banks.
This approach is the next available source of funding if you have learned and implemented the best way to fund a business through personal savings, borrowing from friends, family members and through credit purchase from your suppliers. Venture capital investments are generally made as cash in exchange for shares and an active role in the invested company. Venture capital is different from the traditional financial sources in many ways. Venture capital differs from traditional financing sources in that venture capital typically:
- Focuses on young, high-growth companies.
- Invests equity capital, rather than debt.
- Takes higher risks in exchange for potential higher returns.
- Has a longer investment horizon than traditional financing.
- They actively monitors portfolio companies via board participation, strategic marketing, governance, and capital structures.
How to Raise Business Fund Using Venture Capital Processes
A startup or high growth technology companies looking for venture capital investors typically can expect the following process:
£1. Submit Your Business Plan.
The venture fund reviews an entrepreneur’s business plan, and talks to the business owner(s) to know if they meet the fund’s investment criteria. Most venture funds concentrate on a particular industry, a give geographic area or country, and/or stage of development (e.g., Start-up/Seed, Early Stage, Expansion Stage, and Later).
£2. Do Your Due Diligence.
If the venture fund is interested in the prospective investment, it performs due diligence on your small business; including looking in great detail at the company’s management team, target markets, products and services, operating history, corporate governance documents, and financial statements. This step can include developing a term sheet describing the terms and conditions under which the fund would be used to make an investment.
£3. They Make The Investment.
If at the completion of due diligence the venture fund remains interested, an investment is made in the company – in exchange for some of its equity, assets and/or debt. The terms of an investment are usually based on company performance, which help provide benefits to the small business while minimising risks for the venture fund.
£4. Execute the Venture Capital Support.
Once a venture fund has invested, it becomes actively involved in the company. Venture funds normally do not make their entire investment in a company at once, but in “rounds.” As the company meets previously-agreed milestones, further rounds of financing are made available, with adjustments in prices and processes – as the company executes its plans.
£5. They Exit the Company at Maturity.
While venture funds have longer investment horizons than traditional financing sources, they clearly expect to “exit” the company. On average, this may start from 4 to 6 years after an initial investment, which is generally how they make money; – looking for other young companies to invest in. Although, exits are normally performed via mergers, acquisitions, and IPOs (Initial Public Offerings) where the company has recorded measurable growth. In many cases, venture funds will help the company exit through their business networks and experience.