Startup Funding: Angel, VCs, And What Fits For Your Venture

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By Steph Palmeri (Senior Associate, SoftTech VC) The team at Women 2.0 is compiling a book - "101 Questions About Launching Your Company".

"101 questions," you say?

"Yes, and answers!" from female investors, founders, and CEOs about starting a new venture.

Here’s an early peek. By no means exhaustive, I hope this piece will provide a helpful starting point for first-time founders (women and men) navigating the cloudy waters of raising capital.

Throughout the life of your company, you may receive funding from personal savings (bootstrapping), friends and family, angel investors, and institutional investors including venture capital funds and later-stage private equity funds.

Let’s begin with some of the primary distinctions between angel investors and venture capitalists (VCs) – such as source of investment capital (personal v. institutional), stage of participation (early v. late), and check size ($10K - $10M+) – before examining what is right for your new venture, now and in the future.

Angel investors are individual accredited investors who invest their own capital into one or more startups. Angels are high net worth individuals, many of whom were once founders or early employees of successful startups themselves. Some angels focus their investments on a particular area of interest or professional expertise, while others consider a broader scope of investment opportunities. Individual angels typically write checks ranging from $10,000 to $100,000 or more.

Many angels affiliate themselves with angel groups or angel networks - organizations that enable individual angels to pool deal flow, resources, and capital to increase deal exposure and achieve economies of scale. Generally, angel investors are the first ‘outside’ investors in a new venture (following founders, friends & family investment), and they typically invest in the seed round of funding.

Some angel-backed businesses may go on to raise future venture financing (Series A and beyond from new investors). Other angel-backed businesses may not provide VC-appropriate outcomes to raise additional capital but can provide significant returns to angel investors through exits in the $10-30M range.

Venture capitalists (VCs) are professional investors who invest capital on behalf of their venture fund’s limited partners (LPs). As money managers, VCs invest in and manage a portfolio of companies with the goal of generating superior returns for their LPs via the fund as a whole.

Venture funds generally focus on a particular sector (Internet, bio, clean tech, etc.) and/or stage (early to late). The backgrounds of the venture capitalists investing through a particular fund vary and may include industry or operating expertise, professional investment experience, or even prior experience as a startup founder.

A venture fund may invest anywhere from $500,000 to $10 million or more in a company during a given round of financing; often times venture funds participate in follow-on fundraising rounds for their portfolio companies. For example, a VC may initially invest in a Series A round, then provide additional capital to a company during Series B and C rounds.

To generate an appropriate return on investment, VCs typically back companies that can achieve sizeable, predictable revenue (think <$50M annually) in large markets (<$1B) that have the potential to either go public via IPO or have a substantial exit (<$100M) in the future.

During the last several years, the lines between angel investors and venture capitalist have blurred, particularly in sectors like consumer Internet where the costs to build, launch, and validate a minimum viable product in the market have significantly decreased.

As a result, some individual angel investors look more like traditional VCs, writing checks of $100K or more and participating in follow-on fundraising rounds. These angels are often referred to as business angels or “Super Angels”. Similarly, “micro VC” and seed funds emerged to fill the funding gap between angels and traditional VC investment.

Like traditional venture funds, micro VCs are professional investors who invest via a fund and manage a portfolio of investments, but they specialize in seed stage investments and develop an expertise around the challenges specific to this stage (Full disclosure: I’m an investor at micro VC fund SoftTech VC, which was founded by super-angel-turned-micro-VC Jeff Clavier).

Meanwhile, many traditional venture funds have begun to invest earlier then their typical Series A, B and C rounds, often writing small checks in the seed round alongside angel investors and micro VCs to gain early visibility and access to investment opportunities that may generate VC-level returns in the future.

Whether raising capital from an angel or a VC (or both) makes sense for your company depends on several factors, including your venture’s scalability, stage, current capital needs, and non-financial/support needs.

First, consider how much money your company is likely to need over the course of its lifetime (or at least for the next several years). Are you running a business that requires an investment of initial capital upfront but will generate significant operating cash flows in the short term to limit the need for large injections of cash in the future? Is your business niche or outside of traditional ‘high growth’ sectors like technology or life sciences?

If so, investment from one or several angel investors may be sufficient to get you up and running. Furthermore, a business of this nature is unlikely to produce the return on investment necessary to make it a viable investment opportunity for a traditional venture capitalist.

On the other hand, is your business highly scalable? Does it require a significant investment in technology or infrastructure to achieve FDA approval or demonstrate commercial viability, as in the case of a new drug or alternative energy product? In this case, venture capital funding is right for your business. VCs offer the appropriate risk/reward profile and can provide adequate levels of capital along the growth trajectory of your company.

Next, consider your company’s current stage and the amount of money you will need during the next 18-24 months to grow your business and achieve significant milestones (product releases, customer growth, revenue targets, key hires). At the start of a venture, founders typically bootstrap the company and raise small amounts of money from friends and family.

A seed round ranging from several $100,000s to about $1 millions dollars follows. For a smaller seed round and for companies that only require a minimal amount of capital to achieve profitability, investment from one or several angel investors may be sufficient. For a larger seed round and for companies with high potential/highly scalable business models, a syndicate of angel investors, seed investors/Micro VCs and potentially a VC will allow you to raise more money. After your company has passed the seed stage and you require several million dollars in funding, venture capital funds are the most appropriate target.

Another important factor to consider is non-monetary support and guidance – this will vary among both angels and VCs. Depending on an angel’s own professional experience and desire to be more deeply involved in your company, she or he may be very hands-on (making value-added introductions to key industry players, providing insights from their own operational expertise, etc.) or may be a source of capital only. The same is true when you take institutional venture capital from a seed investor or a more traditional VC.

Some funds are more active (participating on a board, making introductions, even providing resource like temporary workspace, PR or accounting services) while others may be more passive. Active, passive, or a mix of both may be appropriate for your venture - companies and founders have different guidance needs depending on their stage, previous experience, and the businesses themselves.

A final consideration is follow-on participation – if and how an investor participates in subsequent rounds of financing – and the signals this behavior creates in the broader market. Participation varies among both investor type and specific firms.

Early stage investors like angels and micro VCs may have the option to exercise their pro rata (i.e. buy shares in your next round of financing to maintain their same % of ownership from the previous round). However, since these investors focus on seed stage deals, they are unlikely to lead any follow-on financing rounds (and generally look to traditional venture firms to do such).

When traditional venture firms invest in the seed round, several scenarios can play out. The firm may opt to lead your Series A round, may choose to increase their % of ownership but have an ‘outside’ firm price and lead the round, or may simply exercise their pro rata. Their participation decision can send a signal to the larger investment community.

When existing investors back a company in follow-on rounds, it can suggest a confidence in the performance and future growth of the company. Conversely, if an investor opts to not back a previous investment in a later round (for whatever reason, positive or negative), it can signal an insider’s lack of confidence, particularly if the investor traditionally participates in rounds of that stage/size. When raising your round, part of your own due diligence process should be understanding the follow-on strategies of your potential investors in addition to how they will support your efforts to bring on new investors in later rounds.

Simply put, there is no textbook answer to what type of investor is right for your new venture. Because of this, I advise adopting a holistic view of your company’s current and future financing needs, and then identifying stage-appropriate partners that can help you achieve specific milestones and pave the way for future growth through a combination of capital, business support, and network connections.

This post was originally posted at Looking Up.

About the guest blogger: Steph Palmeri is a Senior Associate at SoftTech VC, where she invests in seed stage consumer web and mobile companies. Before moving from NYC to Silicon Valley, she had decade of experience working at the intersection of marketing and technology with both startups/incubators and large companies (Accenture, Estee Lauder, SAP AG). Steph has an MBA from Columbia, sweats bikram yoga, and loves getting lost in foreign countries. She blogs at Looking Up. Follow her on Twitter at @stephpalmeri.