Why Startups Should Carefully Consider Angels vs VCs
Many startups face a dilemma when seeking funding - should they take money from venture capital firms or angel investors? This decision can have major implications down the road. For early-stage startups, nothing beats generating revenue and retaining earnings to fund growth. But when external capital is needed, angel investors can often be a better source than traditional venture capital. Angels align incentives by investing their own money, offer founder-friendly terms and provide hands-on advice. Meanwhile, VCs must balance multiple portfolio companies and incentive structures are often skewed. This mismatch can result in oversized funds, excessive dilution, and lack of value-add support.
The key is to evaluate all funding options through the lens of incentive alignment and value creation, beyond just capital provision. With thoughtful strategy, startups can craft the optimal fundraising roadmap. Venture capital firms offer larger investments, but come with many strings attached. They take an equity stake and often acquire board seats, seeking substantial control over decision-making. This dilutes founders' ownership and authority. VCs expect rapid growth and outsized returns - at least 20X their investment within 5-7 years, through an IPO or acquisition. Angels offer smaller investments, usually at earlier stages. While they seek returns, angels allow founders to retain more control.
Here are some potential things to consider:
In later stages, VC-backed startups often hit roadblocks. If growth stalls, you might become a VC Orphan or VCs may force recapitalizations or sales to "exit" and return capital to their limited partners. But this may not align with founders' wishes. VC firms also face "mark-to-market" pressure - they value holdings on their books at the current perceived market price. Write-downs hurt VC fund performance and ability to raise future funds. So VCs may block recapitalizations or sales that would trigger write-downs, even if desirable for the startup.
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Startups that raise primarily angel funding avoid these pressures. Without VC board members pushing for premature exits or IPOs, angel-backed companies can stay private longer and recapitalize or sell on their own terms. However, less VC funding also sometimes means slower growth. Startups must balance control versus access to capital and resources that supersize growth.
Potential downsides of angel investors
Angels may not have as much experience supporting startups or as many resources as VCs and their priorities may change over time as well. Can't assume interests will remain aligned. Need to evaluate how much and what kind of support you actually need. Angels may have limited capital for follow-on rounds, forcing the startup to find new investors anyway.
Overall, there are tradeoffs between angels and VCs. The importance of aligned incentives and adding value beyond capital remains key when evaluating any source of funding. The key is finding the right investors whose incentives align with yours as founders. This may be angels, seed funds, or VC firms you trust. Evaluate all options to build relationships with investors who will add value beyond just capital.
Ultimately, founders should consider long-term goals and optimal funding partners. Angels offer patience and autonomy, while VCs provide fuel for rapid expansion. But the VC train may derail later stage startups if growth stalls. For founders playing the long game, angels may be the wiser choice.