Startup investment

Many founders are eventually faced with a choice: is it better to finance their future business growth with help from business angels (BAs) or venture capitalists (VCs). The short answer, as so often, is that it depends on individual circumstance. Let’s explore the two options in greater detail.

Image: Paul Martin Eldridge

One key factor influencing the decision to approach BAs or VCs is the level of capital investment being sought. The higher the level of capital, the more difficult it will be to attract business angels, as raising seven-figure sums with angels alone is a major challenge. However, several business angels acting together in a consortium often team together for larger investments, but generally not unless an institutional investor is also involved in the financing.

How innovative is your startup?

VCs often prefer to invest in supposedly safe, already proven copies of successful business models. BAs, on the other hand, are more likely to have a pioneering spirit and to back startups that are untested. Dr. Stefan Glänzer, serial entrepreneur and one of the first last.fm business angels, who also broke new ground with his investment in Mendeley, a provider of collaborative academic software, is a good example of this type of BA. But there are also a number of venture capitalists who enter into higher risk investments in new business models. Index Ventures, for example, has built a reputation for garnering big returns from a higher risk strategy, after successful investments in Skype, MySQL and more recently Playfish.

Business angel contracts are founder-friendly

As a rule, business angels tend to write Shareholder Agreements that are more friendly to entreprenuers. This is especially the case with angels who are less active (Kelly/Hay 2003). So, for example, that standard part of any VC investment – the liquidation preference – may be omitted. Tag-along and Drag-along rights are also not regularly part of agreements with BAs. The more active angels are – that is, the greater their investment – the more their agreements will tend to resemble those of VCs.

Speed of decision-making

As a rule, angel investors are also quicker than the typical VC when it comes to deciding whether to invest. For them there is no multi-level decision-making or deferring up the chain of command. A typical angel investor is an analyst and general partner rolled into one. Due diligence is usually less intensive than would be the case with a VC investment.

Angel investors have the personal touch

Often one can also observe a stronger personal identification from the BA with „his“ company. While with a large VC investor you may just be one of many data points in the portfolio, the typical business angel often has a personal commitment to the company and may be more likely to throw his weight behind it. As Mason and Stark (2004) have observed, when an angel makes the decision to invest, there is greater emphasis on the personal fit between him and the founder/ startup team. Whether this bond exists with angels holding a two-digit number of investments in their portfolio is more doubtful.

Business angels get stuck in

Angel investors are more likely to freely contribute their own time and expertise to companies they have backed. This can range from assistance with legal issues to general strategic advice and business coaching for the startup team, sometimes extending to concrete assistance with operations, e.g. optimising an online marketing campaign. Often, the business angel comes from the same industry sector as the startup and can provide direct help in navigating the murky waters that any new startup must get through. Malte Brettel (2003) found that the overwhelming majority of angel investors (75 percent) had themselves set up a successful startup. As a rule, angels – as well as VCs – also sit on the advisory board of the company.

Hybrid venture capitalists/business angels

By contrast, the support of VCs is often limited to putting the company in touch with useful contacts. Venture capitalists with their own incubators, such as Team Europe Ventures or the Samwer brothers‘ Rocket Internet are a hybrid form of investor. Within the incubators are networks of experienced professionals and successful entrepreneurs offering structured support to startup teams. That is something which a classic VC, with its coterie of partners, investment managers and analysts, simply does not do.

Heterogeneity of the network

A portfolio of different angels with different backgrounds can succeed in gaining access to the kind of heterogeneous network not easily available to a VC. Thus, an angel investor with knowledge of search engine optimisation (SEO) can help a very early stage internet company to avoid failure out of the gates. VCs today may know one or more SEO specialists and may, where necessary, be able to put a startup in contact with one, but often this requirement is not considered „strategic“ enough for them to get involved with.

The investment horizon

While many VC funds have an investment horizon of three to five years and will want their first capital returns in that period, a business angel is not usually subject to such exit pressures. The angel investment is more akin to an Evergreen Fund, which sets its goal as the accumulation and reinvestment of assets without the pressure to cash in.

The exit – the domain of the VCs

When it comes to the exit, whether a Trade Sale or an initial public offering (IPO), VCs have the advantage over business angels. In general they are better networked with potential buyers and have intimate knowledge of when an investment or the purchase of a startup fits into their corporate development. They usually also maintain good relations with financial investors focused on late stage investments. Experienced VCs will have gone through the process of preparing for IPOs before, and this is one area in which their prior knowledge is invaluable. They will know the relevant pre-IPO processes inside out and are likely to have relationships with specific investment banks.

Those with a general interest in the behavior of angels and VCs in the context of IPOs should look at the work of Chahine et al. (2007), which provides an overview of 444 IPOs in the UK and France. Interestingly enough, the average ROI achieved by VCs and Angels was about the same. While VCs total losses outstripped those of business angels, they also tended to have a higher number of „home runs“, investments with a particularly high rate of return.

About author Dr Gerald Schönbucher:

Dr Gerald Schönbucher discusses busines angel and VC financingDr Gerald Schönbucher is CEO and co-founder of Hitflip Media, which runs hitflip.de – a peer to peer platform for swapping games, DVDs and other media products. Hitflip has around 300,000 active members in Germany, Austria and the UK. The group’s other platform hitmeister.de is a marketplace for media products and consumer electronics.

Gut sieben Monate nach dem Start von hitmeister.de war es Zeit, mal bei der hitflip media trading GmbH in Köln vorbeizuschauen. Im Interview gibt Gerald Schönbucher, Geschäftsführer und Mitgründer, einen Überblick über das Angebot des Unternehmens und die Zukunft der Plattformen – vor allem wie man sich von Platzhirschen (im Interview spontan durch die Wort-Neuschöpfung „Szene-Kämpfer“ ersetzt) Ebay und Amazon differenzieren möchte. Daneben gibt es eine kleine Standortanalyse zur Domstadt und im Anschluss eine ausgiebige Büroführung inklusive David Hasselhoff.

Wie im Interview schon angekündigt, gibt es für alle Leser noch einen 5-Euro-Gutschein bei einer Bestellung ab 10 Euro mit dem Gutscheincode: gruenderszene (Noch das Kleingedruckte, sind ja nur Profis hier: Gilt nur für Neukunden. Aufgrund der Buchpreisbindung gilt der Gutschein nicht für Neubücher). Bestimmt findet ihr auch alle Baywatch-Staffeln.