Angel Investors, Family Investment Offices, Venture Capital Firms and Private Equity Firms are common early-stage sources of capital for growth companies when:
1) the business needs capital prior to proof of commercial viability,
2) the business has a strong plan but does not qualify for loans,
3) the business needs substantial capital prior to being cash flow positive,
4) the owners do not wish to take on debt, or
5) the owners want to capture market share rapidly, rather than wait for cash flow from proceeds to generate adequate capital to grow.
Equity investment occurs when something is given to the business in exchange for ownership (equity). Most often the exchange is for cash; however, equity may also be given in exchange for access to assets or distribution channels (via strategic alliances) or talent (in the case of executive compensation).
Private equity refers to privately held money exchanged for ownership, including Angel investment and Venture investment. This ownership would take the form of membership interests in an LLC, or shares in a corporation. And types of membership interests and shares vary, such as common and preferred, which come with different rights.
Deal structure can also vary widely. Some of the most common are priced rounds (purchasing shares at an established price or valuation), convertible notes (a debt instrument that converts to equity), and a SAFE or simple agreement for future equity (does not involve a debt instrument and behaves more like a warrant).
Equity capital can be a great source of capital, but should not be pursued without professional guidance. Several of the many reasons to meet with an advisor first include:
– early investments set the stage for future capitalization of the business;
– terms vary by region, and should be designed to be acceptable to your target investors;
– businesses do not often get second chances when presenting to investors; therefore, being well prepared prior to pitch is important, and
– businesses can spend more money than necessary preparing for investment rounds if they are not working with attorneys experienced with the terms common to the target investors.
Partnering with inexperienced investors or taking equity investment without appropriate documentation can cause business failure or loss of a business. We’ve seen too many good businesses fail for this reason. Well written agreements and choosing investors wisely is strongly advised.
Angel investors commonly take the form of individual accredited investors, family investment offices or angel groups. Angel rounds, which are early capital raises for equity or debt, typically total less than two million dollars ($2M). Over $2M generally moves into the range of Venture Capital.
Angel investment should only be taken from qualified accredited investors; defined as individuals whose net worth is greater than $1M (one million dollars), or whose income exceeds $200k (two-hundred thousand dollars) for the past 2 years.* The U.S. Securities & Exchange Commission (SEC) mandates that only accredited investors are legally able to invest in private companies.
Angel investors expect a clear path to a return on their investment; most often through an Exit. An Exit is when ownership shares of the business are sold through a future equity round or sale of the business. If the angel investors choose well, the future value of those shares should return 5-10x (five to ten times) their initial investment. Therefore, Angels rarely invest in Main Street or lifestyle businesses.
Venture Capital (VC) Firms participate in Series A or B rounds, typically over $2M. We recommend identifying the best VC firms for your industry and fostering relationships early. VCs will often gain a controlling interest, or have stipulations that require formalization of management and systems to prepare for eventual M&A or IPO. The terms Venture Capital Firm and Private Equity Offices are often interchanged, however, they can also be different types of organizations.
A successful Venture Capital relationship for a growing business starts by:
1) finding VC’s that have an excellent reputation in your industry, and
2) getting to know them early so you can decide if they are right for you and they can witness your accomplishment of goals and management through challenges.
*definition as of July, 2020.