Many clients who are pursuing outside funding don’t fully understand the vast differences between venture capital and angel funding. This is unfortunate, because a company that is unaware of those differences is likely to not only waste significant effort but also damage its chances of getting funding. With that in mind, here are some of the most important differences between VC and angel funding.
- Investment Structure. The majority of venture capital investments are structured purchase of preferred stock. In contrast, while many angel investments also purchase preferred stock, there is a wider range of possible investment structures, which include convertible notes, notes paired with attached warrants, common stock, and simple agreements for future equity (a/k/a SAFEs). Depending on the specific situation, these additional forms of investment are often better fits than preferred stock.
- Professional versus Non-Professional Investment. Venture capital funds pool money from third-party investors and then find suitable investment vehicles for the capital they have under management. In contrast, angel investors are affluent individuals investing their own money with flexibility to use their funds in any way they choose and with no obligation to third-party investors. This leads to a higher degree of variability and uncertainty for companies pursuing angel investment. For example, we have seen proposed angel investments withdrawn for reasons such as losses in other parts of the investor’s portfolio or personal issues such as divorce; these types of factors rarely if ever factor into VC investment.
- Valuation. VCs are highly knowledgeable about current market conditions, typically have a substantial number of active investments; they are investment professionals with the experience and knowledge to place a value on a company. As a result, we counsel clients to have an opinion on their company’s value before presenting to VCs, but let the initial statement of proposed value come from the VC. If the company puts a number on the table first, the company’s value might be viewed as unrealistic if it is too high, or money might be left on the table if it is too low. In contrast, angel investors have less industry experience and knowledge, and accordingly have less ability to place a value on the company. For this reason, when presenting to angels it is advisable to have a well-considered valuation figure to present early in the negotiation process.
- Due Diligence and Disclosure. A VC firm will have a standard and thorough list of due diligence items that the company must provide before an investment will be made. Angels, in contrast, likely do not have a standard due diligence checklist, and may require little information. In addition, angel investors often request due diligence items over an extended period of time and in more of a piecemeal manner as those items occur to the investor, which can lead to a protracted and less efficient process. Either way, securities law compliance and good investor relations should be supported by adequate written disclosure to investors of the company’s business, financial position, and risks.
- Post-Investment Involvement. A VC firm usually has clearly defined information requirements, stipulates the right to approve specified transactions, and demands a seat on the board of directors when it makes an investment. Typically VCs monitor the company’s progress without becoming excessively involved, especially if the company is progressing well. Angels, in contrast, have a greater range of expectations. At one extreme, the angel investor with limited time may have a high degree of trust in the company’s management and as a result have a low level of involvement in the company’s operations. At the other extreme, the angel investor with extensive industry knowledge and significant available time may seek to become involved (perhaps overly so) in the company’s day-to-day operations. In any event but especially for angel investment, discussions about the post-closing role of the investor should be part of the negotiations. Keep in mind that once the investment has been made, either type of investor should be consulted about strategic decisions such as company sale, IPO, or admission of new investors, regardless of whether the company is contractually bound to do so.
- Process Management. VC firms have a clearly defined set of processes for due diligence, term sheets, and finalizing definitive documents, and they generally take responsibility for preparing these items, Angel investors, in contrast, typically do not have defined processes and will rely on the company to guide the proceedings. As a result, a company pursuing angel investment must often take the lead in several respects, including drafting a detailed term sheet describing key aspects of the proposed investment, and the definitive agreements.
As noted above, there are many differences between VC and angel funding. However, one common aspect is that the company needs solid legal counsel to assist with:
- offering advice regarding the proper approach to funding and types of funding sources;
- helping the company “get its ducks in a row” in order to be prepared for the due diligence process; and
- guiding the company toward the best possible deal, both at the term sheet stage and later when the parties are negotiating the detailed documents.
Often companies get only one shot at an individual investor, so it’s in the best interest of the company to do its homework, get expert legal help, and be ready to make its best case and proceed on an informed basis.