Business Angels, VC funds, accelerators, grants … There are so many types of investors on the market that it’s easy to get lost. Still, it’s crucial to choose the funding that fits your stage to launch and grow your startup.
Our Head of VC, Pavel Prata created this guide of all investor types for beginner startup founders to help you find the perfect match.
Types of startup investors
There are various types of investors startups can work with. To diversify the investors you need to understand that there are two types of involvement in startups. A hands-off investment approach means that investors give money and little more. When a hands-on approach is used, investors also provide expertise, industry knowledge, and other things to help startups to grow faster.
- Friends, Family, and Fools (FFF) investors are usually people who give your startup money not because they believe in your idea, but because they like you and want to help you.
- Business angels are individuals that invest their capital in the early stages of startup development. Usually, they invest based on the domain they have expertise in or their geographical presence. Fulltime angels are fully dedicated to investing in smaller companies while part-time angels are still working, but already want to diversify their portfolio. To become a business angel an investor needs to be accredited by the SEC in the USA.
- Syndicates are groups of business angels who unite to invest together. Being a part of the syndicate helps people diversify their portfolios and invest in the domains they don’t know much about. Some syndicates have lead investors with their capital and followed by people who simply earned a lot of money and want to invest deal by deal. If there is a lead investor, they get more returns than other people in the syndicate by receiving a Carry (carried interest) — the percentage of profits paid to the lead is typically 15-20%.
- VC funds and micro VCs differ only in the amount of money they manage and the number of staff. A lot of people think about venture funds as an organization of white collars and black ties, but it’s not right. A venture fund stands for the number of funds invested by contributors (general partners and limited partners) and managed by a venture capital firm.
Venture funds use the borrowed capital of investors. Micro VCs can deal with up to $15M and are operated for 10 years by 2-3 business angels. VC funds are operated by more staff with a more complex hierarchy.
Each fund has several circles of its life. Yes, it’s different from a syndicate, because it has a lifetime, generally around 10 years, that helps to fix the prices.
- Stage 1 — fundraising stage before the VC is started, when general partners gather funds from limited partners.
- Stage 2 — investing, which usually takes from 1 to 3 years from the 10-year lifetime. It’s a period when the fund is looking for great deals to invest.
- Stage 3 — helping portfolio companies to grow.
- Stage 4 — exiting, when funds help to find the best exit options.
Venture funds have staff working to help the startups they choose, and this staff needs a salary. That’s why venture funds take management fees for operational expenses. Usually, such a fee is 2% per year. So if you gathered a 10-year fund for $100mln then $20mln will be taken by the fund for their expenses.
- CVCs (corporate venture funds) are venture funds with no lifespan that usually invest strategically in technology. There are no investors and there is no need to fixate on profitability. Simply put, it’s like Google creating its fund as a separate private company.
- Accelerators are organizations that help startups with knowledge and expertise. They are basically educational programs based on 3-months cohorts. If an accelerator has chosen a startup, it will provide it 3 months of assistance for some sum of money in exchange for equity.
- Classic Venture Studios are companies that develop startups. They can specialize in one or several categories. Studios are more hands-on than other investors. Different from accelerators, venture studios help startups their whole lifetime dive super-deeply into the operational processes.
Venture studios fall into 2 categories, or mix these together:
- Studios that develop their own products but look for a CEO to take the lead during the first traction. In such a scenario, studios give the new founder around 20% of equity and help them to grow the startup.
- Studios that develop founders’ products and help these founders with development, launch, growth, support, marketing, and so on for a part of the equity. This approach is similar to what we provide in Paralect.
Other funding sources to consider
- Bootstrapping is a process by which an entrepreneur starts a self-sustaining business, markets it, and grows the business by using limited resources or money. It’s an ideal way to grow your startup in the early stages with your own finances and with no shared equity.
- Crowdfunding is a way to gather collective investments as donations. Usually, the amount of money is not so big, but if the founder manages to attract a lot of people in the campaign, the investment can become significant.
- Grants are donations on a gratuitous basis to usually socially significant projects. The social significance is the most important here because without it the project generally can’t apply for a grant.
What type of investor is appealing and how
Let’s summarize the pros and cons for each type of investor.
Friends, Family, Fools (FFF)
• You stay the sole owner of the company • You don’t waste your time finding investment opportunities on the early stages
• Hands-off approach • Risk of family conflicts over money (each family gathering becomes a meeting with investors) • Usually have less money to invest, so more of them are needed to reach financing goals
• Hands-on approach • First to believe in the startup and provide mentorship • Usually invest at early stages • Can organize an intro with later investors • Little paperwork
• They get part of the company’s shares • Some business angels are useless or getting too involved in startup life that there is no place for founders to maneuver • Additional investments will be needed
• Hands-on approach • Have access to higher investment amounts + expertise + networking • No lifetime • No management fee
• Similar to business angels
• Hands-on approach with lots of expertise in various domains • Bigger investments for the startups • 10-year lifetime • Management fee 2%
• Splitting the equity with another company that can turn out to be useless or bad (often compared to bad marriage)
• Same as micro VCs, but the budgets for investments are bigger to scale quickly
• Similar to micro VCs • More paperwork and bureaucracy • Longer negotiation process • May have to give up some control over the company for funding
• Can bring expertise and staff • Even bigger investments opportunities • Help with customers and launching on the market
• Even more paperwork and bureaucracy • Longer negotiation • They get part of the company’s shares • Having CVC as an investor can lead to conflict of the interest with later investors
• Give great motivation to develop and grow fast due to the short time of the program • Hands-on approach
• 80% of accelerators don’t bring real value • Splitting equity forever for the temporary help
• Total hands-on approach • Help with operational processes • Can help to fill the funding gap (no need to raise new levels of investments)
• Big % of equity taken — it can be a blocker for late stage investors • Can take control out of founders hands
• Real motivation, speed of development and great level of investors commitment • Save you from any debt and wouldn’t cost you your equity since the entire idea will be facilitated by your resources
• No hands on approach, founders work by themselves • Risk of financial losses • No so much place to experiment
• Full control over the company • New way to attract customers • Validating idea right in the process of crowdfunding
• No side expertise available • Takes a lot of time before starting the actual campaign • Plenty of financial limitations
• Almost free money to attract just for a vision • Once one grant is received others usually follow like a waterfall • Great for idea stage
• Takes a lot of time to initiate • Lots of pitches needed • No side support in terms of the expertise • Depending on the niche there may be some restrictions
It’s a common practice to start with FFF investments and bootstrapping in the beginning to gain traction and growth towards further types of funding later.
No matter how you decide to fundraise and what types of investors to attract, you need to think in advance and see the whole picture. Don’t just think about the immediate future, plan for later to see how each investor will help you benefit on a larger scale and make venture capital work for you.