Taking the Next Step: Crowdfunding vs. Angel Investment vs. Venture Capital
10 minute read
Having a business idea that can make a difference and impact your industry is a prerequisite in the world of business. However, while you may have a fantastic business idea in mind, you should be aware that no materialization of that idea is possible without proper funding.
Therefore, the next logical step for you is to acquire the necessary funds and start building the business you have in mind.
Unfortunately, funding tends to be one of the key challenges when starting a business. And while there are quite a few options you can turn to, none of them guarantees success.
But have no fear. To help you decide on the right type of funding for your business, we have created this comparison between crowdfunding, angel investment, and venture capital.
- What is Crowdfunding?
- What is Angel Investment?
- What is Venture Capital?
- Main Differences Between Crowdfunding, Angel Investment & Venture capital
What is Crowdfunding?
Raising funds or capital from individuals or organizations that invest in (or donate to) projects in return for a potential profit or a reward is called crowdfunding.
We have witnessed significant growth in the popularity of crowdfunding thanks to platforms such as Indiegogo or Kickstarter. This rise has indicated great advancements for non-profits and other organizations. Thanks to this concept, many startups have secured the needed funds to launch their ideas and show the world what they have to offer.
However, keep in mind that in most jurisdictions, restrictions apply to who can fund a new business and how much they can contribute. These limitations are similar to the ones dealing with hedge fund investing.
These measures are supposed to protect unsophisticated or non-wealthy investors from putting too much of their savings at risk. After all, there are a number of businesses that fail and their investors face a high risk of losing their principal.
The majority of crowdfunding projects are based on rewards. To be precise, investors may get to participate in the launch of a new product or receive a gift for their investment. For example, the developer of a new video game may send a free copy of the game to each of the investors as a small gift.
Additionally, it is worth mentioning that equity-based crowdfunding is slowly becoming more and more popular, since it allows early-stage businesses to raise money without giving up control to venture capital investors. Still, this type of crowdfunding also allows investors to earn an equity position in the venture.
Take a look at the advantages of crowdfunding:
- Keeping equity. Investors are not shareholders of the company. This is the main benefit and the main reason why many entrepreneurs choose crowdfunding as a method to raise enough funds for their businesses.
- Low financial risk. This kind of funding enables entrepreneurs to test the waters and see if their idea has merit without having to take a lot of financial risks.
- Tapping into an existing community. Crowdfunding allows you to leverage an engaged community that is already looking to support ideas such as yours.
On the other hand, there are various shortcomings of crowdfunding:
- Sustainability problem. This method is not sustainable in the long-run nor it is an accurate representation of how successful the business venture will be in the market.
- It may take some time (and money). Successful crowdfunding campaigns require a lot of effort and even the founders have to invest some amount of money to build prototypes, marketing videos, and so on.
- Idea theft. Many entrepreneurs forget to protect their ideas and sometimes they get stolen. It often happens that established companies try to mimic what an entrepreneur is building.
What is Angel Investment?
Angel investments are made by wealthy individuals (such as accredited investors) that invest their personal money into a company in exchange for equity in that company. This is the basic principle of angel investing.
These individuals are usually accredited investors, which means that the person investing has a net worth of at least $1 million, or they had an individual income of $200,000 each of the previous two years and an estimation of the same for the current year. Being accredited is also possible if they and their partners have a combined income of at least $300,000.
Angel investors help startups during the seed stages, so there is a higher risk in angel investments since they are connected to unproven business models. Also, if the company does not have a product or even if they have customers, they might not have significant revenue.
But angel investors are more forgiving about the metrics that venture capitalists use to measure a potential investment. In fact, many business professionals believe that angels expanded the reach of the venture capital model.
Since angel investors can work independently or in large groups, it is not unusual for a typical investment to range anywhere from $25,000 to $100,000. In addition, there are cases when angel investors contributed even more than that.
Here are the advantages of angel funding:
- Great for companies that need quick capital fast. Getting the right funds at the right time can make a huge difference when it comes to business success.
- Funds are not loans. There is no legal obligation to repay what is borrowed as one would have to do with business loans. Angel investors do not expect money in return, they are banking on the company increasing in value as it grows.
- Angel investors do not only provide money. These individuals are often well-established business professionals with years of experience under their belts. They can also help companies by sharing their thoughts and even guidance.
Let’s take a look at some disadvantages of this kind of funding:
- Higher risks. Since there is no obligation to repay the investment, investors face higher risks.
- Pressure can be quite difficult to handle. Investors want to see their investment pay off in a tangible way.
What is Venture Capital?
Venture capital investment may just be the most popular way of raising capital even though crowdfunding really witnessed a boom in recent years.
Venture capital is a form of private equity and a type of financing that investors provide to startup companies and small businesses with long-term growth potential.
These funds are pooled investment funds that manage the money of investors who seek private equity stakes in startups and small to medium-sized businesses. Naturally, venture capitalists want to see real potential in something before they decide to help. Venture capital firms usually make investments that are characterized as very high-risk and high-return opportunities.
To better understand what these funds are, we will dissect the concept behind them.
Venture capital (VC) is a type of equity financing that provides entrepreneurs with the opportunity to raise funding before the operations have begun. In other words, no revenue has to be earned in order to acquire the funds.
Venture capital funds are quite different from mutual funds and hedge funds, since they focus on a very specific type of early-stage investment. All businesses that receive venture capital investments have high-growth potential, are risky, and have a long investment horizon.
VC funds have a more active role in their investments by providing guidance and often holding a board seat. They are seen as either seed capital, early-stage capital, or expansion-stage financing, based on the maturity of the business and the time of the investment.
However, all venture capital funds have a fairly similar way of working. Like all pooled investment funds, venture capital funds have to gather money from outside investors before they make any investments of their own.
Finally, investors make returns when a portfolio company exits, either in an IPO, or a merger and acquisition.
Below are listed the advantages of venture capital financing:
- Larger pool of capital. VC funds can sometimes amount to quite a large amount of money. This means that the business gets a fantastic initial investment.
- Money stays there. VC firms take a gamble on businesses. If the business succeeds, they win. And if they lose, they eat their losses. Contrary to bank loans, there is no obligation to repay VC funds.
- Good connections and networking. Venture capitalists are generally very successful entrepreneurs in their own areas of expertise and they tend to have contacts that other business people don’t.
And now the disadvantages of venture capital financing:
- More difficult to attract investors. Seeing that more money is at stake, only the high-potential businesses get to obtain this kind of funding.
Main Differences Between Crowdfunding, Angel Investment & Venture Capital
Let’s go through major differences between angel investors, venture capitalists, and crowdfunding :
Angel investors usually help with amounts between $15,000 and $70,000, with the average Business Angel investing a median of $30,000.
Keep in mind that angels invest personal finances into startups, whereas VCs invest through managed funds.
Considering that VCs draw assets from a large pool of resources, they invest larger sums than the rest. These amounts vary somewhere between $2,500,000 to $70,000,000.
However, if angels invest as part of a syndicate, even larger amounts of finance above $2 million can be raised.
Keep in mind that this is a bit difficult to determine since the numbers vary from region to region. But it is worth noting that crowdfunding has the capability to aggregate a variety of investment sources into one funding round.
Hence, it is not necessary to turn away other investment opportunities. Instead, combine various forms of monetary help and you might obtain a lot of funds to kickstart your business growth.
Who Do They Usually Invest In?
Angel investors usually invest in earlier stage businesses, while venture capitalists look to invest in startups with proven business models that are looking to scale. VCs are more risk-averse than angels and they make fewer small investments in startup and seed-stage companies.
On the other hand, crowdfunding is suitable for startups of all stages.
Involvement Of Investors
Angel investors are involved in the sense that they often offer an advisory role. Moreover, they may take a role on the board and connect your business to other prominent business names of the industry. Some angel investors are a bit passive, while some involve themselves completely.
On the other hand, VCs almost always tend to demand a high level of involvement in a business. They often require a seat on the board, since they want more control over the investment return. This kind of involvement can be of great help, but the constant control and monitoring can present a strain on the board members.
Finally, since crowdfunding allows thousands of supporters to invest, a large shareholder base results in a heavy administrative burden. Still, it is worth mentioning that this varies from one crowdfunding platform to another.
How Long Does It Take To Acquire Funds?
To understand this, it is important to denote that due to significantly larger amounts of money VCs invest in startups compared to angel investors, they spend more time to consider their involvement with a business and complete their research.
Angel investors operate alone or in small syndicates and they can make quicker decisions. Also, VCs have to be more bureaucratic and that plays a significant role in the process too.
When it comes to crowdfunding, the situation varies from platform to platform. Some take no longer than two weeks for the whole process to end, while others can take months. Either way, once a campaign reaches its target, it should not take too long to transfer the amount.
There will probably be some challenges in the process of securing the investment, but new technologies and initiatives should help you raise enough money.
Carefully consider if you want angel investors, who are good for startups wanting to raise large amounts of capital without facing requirements that go along with loans. Crowdfunding is great, but the fees can quickly add up, while VCs require a lot of involvement and monitoring.
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