The ideas which we will discuss today can be set up with a simple analogy of Little Barry and his lemonade stand.
Little Barry’s Lemonade Stand
Little Barry owns a lemonade stand. He sets up outside his house, and it seems to go well. He manages to sell 5 or 6 jugs of lemonade, but he eventually exhausts the resources available in his house. Little Barry requires money to buy supplies of sugar and lemons i.e. he needs somebody to invest in his business.
Barry encounters two types of investors he can pitch to- angel investors or venture capitalists.
Angel Investors
Angel investors are individuals who invest money from their own pocket in exchange for a minority stake, around 10%-30%. They can be family, friends or anyone who sees potential in your business idea.
Angel investors don’t invest a significant amount (usually $1,000-$50,000), however their terms are usually much more lenient, and they accept the possibility that a start-up could fail at any time.
The relationship between an angel investor and early business employees could be close, with investors providing time, experience and skill to lift the business off the ground.
Angel investors typically have already made a large sum of money. Sometimes, angel investors can group together and invest in potential business ideas. The group may have a lead angel, who spends the most time with the business.
A famous example of a group of angel investors is the cast on Shark Tank.
In Barry’s case, a potential angel investor may be a rich aunt or uncle who has some spare money to invest in Barry’s lemonade stand.
Venture Capitalists
A venture capital firm (VC) raises a private equity fund (an investment in a private company that is not yet listed on the stock exchange market) from a pool of investors looking to make money.
These investors are known as limited partners (LPs). Venture capitalists manage the fund, and search for lucrative business opportunities in which to invest this money.
The investors who put money into the VC firm interact little with the business the VC firm invests in. Business decisions are influenced by the venture capitalists rather than the limited partners.
LPs simply hold a stake in the company. They hope that their investment, coupled with the skilful strategies of venture capitalists, will return profits.
Venture Capitalists aim to maximise profit for their LPs in order to receive a percentage of the profit earned by their efforts.
A large pool of money from many investors helps fund large business deals which could maximise profit.
Investors may be individuals, or large organisations with a lot of money to spare.
In Barry’s case, venture capitalists may be a group of people he trusts to help manage his lemonade stand for him. The VCs raise money from his friends and family, who each invest a little amount.
Which One: Angel Investors or Venture Capitalists?
While both types of investing have their own merits, little Barry’s lemonade stand and similar start-ups may find it beneficial to start with angel investing. Venture Capitalists work with large sums of money, and so typically invest in companies that have already made a significant return in profits.
This displays to VCs that the company has a good foundation, and with more money can grow significantly.
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Cover Image– Venturz