WHO am I Taking $$$ From?!?— Venture Capitalists, Angel (Shark Tank) Investors, and The Crowd—And Wh
You have an amazing company and need money (seed capital) to keep
growing. The question is who are you going to take it from? It can get very confusing very quickly. This article attempts to untangle the web and explain the different parties involved in your raise.
Venture Capital Firms
This term is thrown around a lot, but let’s break it down a bit. Venture capitalists (VCs) invest in high-risk, high-growth startups which traditional financial institutions (banks) can’t. Here is an article discussing the history of venture capital. VCs try to reduce investment uncertainty through careful screening of proposals and by taking an active role in the management of their companies. They often have certain expertise or connections and can lend invaluable advice to startups and entrepreneurs.
VCs traditionally do not lend money (debt), but rather exchange capital for an ownership (equity). Using equity rather than debt allows young companies to reinvest their earnings and enables venture capitalists to absorb substantial investment risks, since one successful investment will counterbalance several break-even investments or even outright losses. The time horizon for payback can vary, but VCs traditionally look for ten to a hundred times return over a period of five to ten years. Venture capital firms also reduce risk is by investing in syndicates (co-investing) with two or more venture capital firms or angel investors.
Angel Investors (The Sharks)
Angel investors—AKA private investors, informal venture capitalists, or sharks from the famous ABC show ‘Shark Tank’—are wealthy
individuals who personally finance the same new, unproven ideas and businesses as venture capitalists. Angel investors usually invest just before entrepreneurs would qualify for VC funds. The companies that angles invest in usually do not have any operating history, therefore problems such as extreme levels of uncertainty, information asymmetry, and agency costs in the form of potential entrepreneurial opportunism can be even more severe than at the time venture capitalists invest.
An angel invests her own funds, as compared to venture capitalists who invest the funds of others. It is important to note that while the name suggests an altruistic motive, angel investors expect the same equity percentage of the enterprise they finance that venture capitalists require However, due to the added risk they invest less money and expect more growth opportunities.
Accredited Investor
An accredited investor is a legal term defined by the Securities and Exchange Commission (SEC) in Rule 501 of Regulation D. It means that an individual has over $1 million in net worth, or income over $200,000 in each of the last two years (or $300,000 with spouse) and reasonably expects to reach the same income level in the current year. There are many companies that operate under a Regulation D exemption (Rule 505 and 506) Meaning they sell their products exclusively to accredited investors.
Angel investors are typically accredited investors. Once an accredited investor makes an investment in a growth company they automatically become an accredited angel investor.
Private Equity
If you are a startup, you can basically write private equity off as a source of funding. Private equity funds either purchase established private companies or publicly traded companies. Private equity firms are limited partnerships that hold equity ownership of companies. Investment professionals serve as the general partner and investors are limited partners (the moniker denotes their limited liability). The investors are always accredited investors as minimum fund raises are typically $250,000 and can be upwards of several million.
One of the most well know tactics of private equity firms, is corporate raiding. This is when a fund will buyout ALL the shares of a public company resulting in a delisting of the company. They will then try to clean up the balance sheet of the company and sell it back on the public market within four to seven years.
The Crowd
The Crowd is an exciting new investment partner that has only become viable in the last few years with online funding platforms. You have undoubtedly heard of Kickstarter or similar crowdfunding sites. Crowdfunding sites allow the Crowd, or any person in the world, to invest a small amount of money in exchange for a product or service. As of the date of this article almost $3 billion has been pledged on Kickstarter alone.
But, since May 16, 2016, when the SEC released the much-anticipated rules on equity crowd funding, the Crowd can now invest in equities. Accredited investors could invest in equity sales since 2013. The change was made by the Jumpstart Our Businesses (JOBs) Act and required the SEC promulgate the rules. WeFunder is one of the major names in the equity crowdfunding space that is marketing solely to the Crowd and not operating under a Regulation D (accredited investor) exemption.
If you are contemplating taking money from an angel, a shark, or the Crowd send us an email or give us a call so we can walk you clearly through the best options.
This article was written by Curtis Roberts, the founder of The Founder's Attorney.
If you have any questions or suggestions he can be reached at curtis@foundersattorner.com. You can check out his LinkedIn page here.
This article is for general information only. The information presented should not be construed to be formal legal advice nor the formation of a lawyer/client relationship.
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