If you have a habit of following financial news, you might have heard of startups raising funds through venture capitalist firms. Have you ever wondered what venture capital financing is? 

Venture capital financing is a highly popular way that startups and small businesses use to raise funds. It involves reaching out to venture capitalists with a proposed business plan, who after a thorough analysis can choose to invest in the business by purchasing its equity. Venture capitalists are usually investment banks and other financial institutions. In addition to providing the necessary funding for businesses, venture capitalists also provide financial, technical, and managerial assistance and expertise.  

Key features of venture capital investing

There are several key features of venture capital investing that set it apart from other forms of financing. Here’s a quick look at a few of them. 

• High levels of risk 

Venture capital investing carries very high levels of risk. This is due to the fact that venture capitalists invest in companies that are often just starting out in their journey. Since there’s very little to no track record of the performance of the company, there’s no guarantee of any return on investment. However, if the business that venture capitalists invest in manages to take off, the returns that are generated typically tend to be very high as well. 

• Illiquidity 

Venture capital investments tend to be illiquid in nature. This is simply due to the fact that selling the stake in the equity of a company that’s up and coming is extremely difficult. The only form of exit for venture capital investors usually arrives when the business they invest in files for an IPO. At which point, the venture capitalists may choose to sell the stake that they hold through an Offer for Sale (OFS). 

• Participation in the decision making process 

Since venture capital investors hold a portion of equity in a business, they’re also typically involved in the decision making process. They have the power to vote on resolutions and various other business decisions, influencing the way the business is managed.  

• Share in the profits  

Being a shareholder in a company, holding onto a portion of its equity, venture capital investors are entitled to a share in the profits. Once the business starts becoming profitable, the profits are distributed to the venture capitalists. This is typically when the investors start seeing returns on their investments. 

What is angel investing? 

In venture capital investing, where the primary investors are mostly investment banks and large institutions. However, when it comes to angel investing, the investors are generally individuals with a high net worth. Also, angel investing involves the investors using their own wealth to invest in a business rather than making use of an investment fund, which is usually the case in venture capital investing. 

Even in angel investing, the angel investor receives equity in exchange for funding a business. This equity that the investor gains is held until the company becomes profitable and lists itself in the stock market via an IPO. One of the highlights of angel investing is that any individual may become one, provided they have enough net worth to invest in a business. 

Things to keep in mind before getting started with angel investing 

Although anyone can become an angel investor, there are certain things that you should keep in mind before you start investing in a business. Here’s a quick look at a few of them.  

• Understand the risks involved

Angel investing is a highly risky affair. There have been many cases where angel investors have lost their entire capital as well. Therefore, it is very important to understand the risks involved in angel investing before you decide to jump into the bandwagon. This will help you make more informed decisions. 

• Find the right startup

This is arguably the most important thing that you would have to keep in mind. Since angel investing is a risky affair, finding the right startup to invest in is extremely crucial. Investing in a startup just for the sake of investing is not the right way to go. Always stick to businesses that you know and understand.  

• Invest with other angel investors 

It is always a good idea to band with other angel investors. Going the route of angel investing alone is generally not advisable. When you have co-investors with you, business research and mitigation of risk is generally easier. 

Venture capitalist vs angel investor: 5 key differences 

Now that you’ve seen who a venture capitalist and an angel investor is, let’s now take a look at the difference between them both. The table below outlines the difference between angel investors and venture capitalists in a more readable manner.  

Wrapping up

With this, hope you have now understood what a venture capitalist and an angel investor is and the differences between them. In the next chapter, we’ll delve into two other methods of funding - P2P lending and merchant lending.  

A quick recap

• Venture capital financing involves reaching out to venture capitalists with a proposed business plan, who after a thorough analysis can choose to invest in the business by purchasing its equity. 
• It carries a high level of risk, but gives the investor a share in the profits and participation in the decision-making process of the business.
• When it comes to angel investing, the investors are generally individuals with a high net worth. Also, angel investing involves the investors using their own wealth to invest in a business rather than making use of an investment fund, which is usually the case in venture capital investing. 
• There are many differences between venture capitalists and angel investors.