To fully understand what venture capitalists and angel investors are, it’s important to first have brief knowledge on what a venture capital and angel investment do.
* Venture Capital and Venture Capitalist
Venture capital, otherwise known as Venture or VC, is a type of private equity capital usually provided for young but high-potential growth companies with the main interest of having a return through a future realization event like a trade sale or IPO. Generally, venture capital investments are made as cash to trade for shares in the company where the investment is made.
It’s common for venture capitalists to determine and back the companies with high technology such as ICT and biotechnology. Typically, venture capital comes from high net worth individuals and institutional investors and is joined together by committed investment firms, also called the venture capitalist.
A venture capitalist is the investment firm or individual that makes the venture investments. These venture capitalists should bring the technical and managerial expertise and the capital to their investment. Venture capitalists are usually interested in new companies with short or limited operating history, small companies that cannot raise enough capital in the public market and those companies that have not yet reached the point where they can complete a debt offering or secure a bank loan.
In exchange for the risks that venture capitalists take by putting their investments in less mature and smaller companies, they usually assume significant control over the decisions of the company, aside from the significant portion of the value and ownership of the company.
* Angel Investment and Angel Investor
Angel investments can bear extremely high risk. These investments are usually involved in dilution from investment rounds in the future. As such, angel investments require an extremely high ROI or Return on Investment.
Since a large percentage of these investments are completely lost when the company fails at its earlier stage, professional and experienced angel investors look for investments with high potential to give returns of their original investments of at least 10 times or even more in a period of 5 years; by using a defined exit strategy, like plans for an acquisition or initial public offering (IPO).
An angel investor, otherwise known as informal investor or business angel is a well-off individual who provides the capital for a business start up, usually in exchange for ownership equity or for convertible debt. Angel investors organize themselves to form an angel network or angel groups to share their research and combine their investment capital.
The best practices of angel investments suggest that angel investors might have better performance by setting even higher sights and looking for potential companies that will have a potential to give a return 20 times or 30 times higher over a 5 to 7 year holding period.
After considering the need to cover the failed investments as well as the multi-year holding time even for the successful ones; however, the effective IRR or internal rate of return for a commonly successful angel investment portfolio is actually as low as 20% to 30%.
While the need of investors for higher rates of returns on any given angel investment can therefore make angel financing a very expensive and costly source of funds, cheaper capital sources are often not available for young ventures, which may be too young or small to qualify and be approved for traditional loans.