Charlie Had His Angels And Your Start-up Can Too — Angel Investors And Venture Capital Firms: The Pitch, The Deal and Your Obligations
If you have already founded a start-up or are in the process of setting up your own business, you might have an idea about the different ways of funding your initial setup or might have already done your research to see where most companies have found their financial support. Usually, companies seek to obtain funding from large, financially strong stakeholders such as ‘angel investors,’ who are willing to inject money into newly founded companies in the hopes of a profitable return. Angel investors could be a good opportunity for any start-up to seek funding from. But what exactly does an angel investor do?
Angel Investors:
An angel investor is a high-net-worth individual who provides financial support for start-ups. This financial contribution is offered in exchange for equity ownership in the company. When people start their own business, the aspiring entrepreneur may initially seek out investments and financial assistance from family and friends or pour some of their own capital and savings into the company. However, such investments are only usually sufficient for the early stages of the company to kickstart its business, not to mention that putting all of your available personal funds into the business adds a lot of personal risk of insolvency if the business fails.
On the other hand, angel investors provide the same type of support but in a more professional and framed way. Angel investors may support the start-up in two ways: either with an initial investment that would allow the start-up to gain visibility in the marketplace or through ongoing financial injections to ensure that the company grows steadily so that the investors may, at some point, get their money back and make profit on top of it.
With the rising prospects of the start-up landscape, angel investors have become key figures for start-up founders. There are clear terms and conditions for how the relationship will work that are set out within the investment agreement signed between the company and the angel investor. There are also associations where a company can find angel investors tailored to their specific needs, as well as several tools and resources facilitating the process of selecting these angel investors. We provide information on some of the major UK associations of angel investors later in the blog.
Venture Capital Firms or Funds:
What are venture capital firms?
Another prominent stakeholder worth mentioning when discussing initial investments and where to obtain financial support for the start-up are venture capital (also referred to as VC) firms or funds. A venture capital firm is created by several partners, each called venture capitalists, with the aim of making investment decisions. After an initial screening of many start-ups and the identification of the specific start-ups that the fund believes to be most promising, the fund will deploy the necessary and pre-decided capital to these start-ups.
Venture capitalists vs. Angel investors
In contrast to angel investors, who are high-worth individual investors or groups of high-worth individual investors, venture capital firms are limited partnerships. This means that they are companies with board members, directors, people in managing positions all of whom need to approve the investment. Though the individual venture capitalists who work for venture funds may not be as high-net worth individuals as angel investors, they still have the backing of substantial capital that start-ups can utilise.
Another significant difference between angel investors and venture capitalists is that venture capital firms are not usually targeted towards start-ups from their infancy. Instead, they target already funded and established firms that are looking for financial support to commercialise their idea further. The aim is to obtain as much return on investment (ROI) as possible, which might be translated into a liquidity or a ‘cash-out’ response.
Furthermore, venture capitalists are more likely to engage in investment opportunities once there is a strong management team in place at the business and also a clear and defined market for the business. While angel investors invest in the initial stage of the start-up when there are no palpable results or direct market engagement, venture capitalists tend to invest in firms of a remarkably similar profile portfolio.
Investment risks: Venture capitalists vs. Angel investors
From a risk perspective, venture capitalists are in a much more perilous financial position than angel investors due to the massive return that the venture capitalists expect from the companies in which they invest. This risk difference is because of the way venture capitalists invest and process the benefits of their investments: while part of the money is distributed to the partners, some money will also stay within the venture capital firm or fund itself to further business investments and ventures. By comparison, angel investors aim to support the company they invest in and allow it to grow and may not necessarily expect immediate returns. For a venture capitalist, the aim is direct and accountable economic profit. [1]
Equity: The Key Question
When starting up a company, investors (whether it be angel investors or venture capitalists) will seek equity in the company in return for their investment. By issuing equity to these investors, your business will also benefit from their expert advice, given that their financial investment -and of course their financial returns from it- will now be tied to the success of your business.
For investors (including both angel investors and venture capitalists), it is paramount to establish how much equity an investor receives in the investment agreement. There is no set or specific percentage of how much equity ownership you should give to investors. It may depend on different factors such as company valuation, the size of the investment and any potential agreement that has been discussed before the investment.
As mentioned, it is important that you specify the percentage that the investors are entitled to as part of the investment agreement. Some investors may also ask for a percentage of control or voting powers within the company for important decisions that need to be made in the day-to-day business. These issues are definitely something that you need to consider carefully before you start negotiating the investment agreement with any investor.
How to Find Angel Investors and Venture Capitalists in the UK?
Due to the increasing desire for companies to seek out investments for growing their business, there is an increasing number of associations in which both angel investors and venture capitalists gather and can meet companies or start-ups at the different levels and timings of the evolution of the companies.
Here are four websites that can provide you with links, tools and contact information about potential investors in the UK:
· The UK Angel Investment Network — Business Angels, Entrepreneurs & Angel Investors
The UK Angel Investment Network can be a great first step in identifying potential investors and matching funding needs with funding opportunities. Aside from being the first stepping stone to find investors, it also includes a subscription service where you can create your pitch and publish it for investors to see. In a pitch, you will be able to present your start-up, identify where you need support and include the estimated amount of funding you require, among other details. There is also the possibility to obtain paid support for the development of your pitch.
· Entrepreneurs — UK Business Angels Association (ukbaa.org.uk)\
Similar to the UK Angel Investment Network, the UKBAA not only is a meeting point between start-ups and investors but also provides legal resources and educational documentation on the markets and the start-up scene that can be very useful for aspiring entrepreneurs. In addition to this, the UKBAA organises events where you can participate and discuss current trends in the market.
· BVCA | British Private Equity & Venture Capital Association > Home
The BVCA, like the two networks mentioned above, handles policy and research aspects of investments, and provides a connecting platform for investors and entrepreneurs. It also offers general market information and insights. Another major benefit of BVCA is that it offers detailed and extended training to companies, covering a wide array of topics that a start-up needs in relation to venture capitalist investments. Having a strong focus on the ESG (Environmental, Social, Governance) aspects of start-ups, it constitutes a solid industry portal for building a sustainable business.
· List of top UK Venture Capital Investors — Crunchbase Hub Profile
The business world in general relies on the internet to find publicly available, free databases. Crunchbase is a great tool for obtaining publicly available information organised in a specific format. This resource can help you develop a list of individuals to whom you can start pitching your idea.
Summary:
Depending on the stage of your company, an angel investor or a venture capitalist can be a game changer in turning your start-up into a company with strong foundations, or kickstarting your product and increasing its prospects for further commercialisation. Depending on what your business is looking for, you need to remember that both types of investment pathways come with significant risks for your enterprise. For this reason, it is important to keep yourself informed and to read and understand all the details and conditions in any investment agreement you are considering signing.
A good way to increase your understanding is to receive appropriate and relevant training and information with respect to investors. Through such training, your company and employees will build a proper understanding of the terms and conditions that different investors may request and the impact those terms and conditions will have on your business. Moreover, once your firm becomes successful, you will be better placed to set clear boundaries on ownership and management when more investors come into play.
[1] For further reading:
- Angel Investor Definition (investopedia.com)
- Venture Capitalist vs. Angel Investor | Who Should You Pitch to? (patriotsoftware.com)
This article was written by Anabel Martínez-Marí De Haas and Christos Sakellaropoulos, LLM students participating in qLegal, Centre for Commercial Law Studies, Queen Mary University of London
qLegal provides pro bono legal advice and legal education to start-ups and entrepreneurs on intellectual property, data protection, corporate and commercial law. See the qLegal website (http://www.qlegal.qmul.ac.uk/) for more details and to book your appointment now. Follow us on Twitter and LinkedIn for regular updates on issues relevant to your business.