Starting a new business can get expensive, as can growing an existing one. Many entrepreneurs fund their startups with their own money, along with whatever they can get from family and friends. When that runs out, it's time to look to outside funding sources. Unfortunately, banks tend to consider small startups that have yet to make a profit as too risky for loans.

Venture capitalists and angel investors are private investors that can provide the cash infusion your small business needs to grow. Both expect an interest in your company, a significant rate of return (usually no less than 20%) and a plan for cashing out in a few years. However, in all other significant aspects, angels and VCs tend to operate quite differently.

Angel Investors

Most angel investors are wealthy individuals who invest their own money into companies they would like to see succeed. They may have experience in your industry, and will often want to bring their knowledge to your company along with their money. This doesn't necessarily mean they want to be heavily involved in day-to-day operations. Some do, but others act in more of an advisory capacity, and many are hands-off, as long as you can deliver the promised returns.

Angels typically invest small sums, even as little as $25,000, often into the early stages of a company. They rarely invest more than about $500,000.

Venture Capitalists

Venture capitalists may be individuals investing their own money, but more often they are groups of professional investors investing third-party money. They may or may not have any actual business experience within your industry, although some do concentrate on specific industries. Others fund companies in certain areas of the country or stages of development.

VCs rarely invest in early-stage startups. They want to see evidence that a company can be profitable. They also prefer to invest large amounts of money, usually a few million dollars minimum, so a company that only needs a few employees and very little equipment probably isn't a good fit for most VCs.

VCs will also expect a lot of input into your company. They usually want a seat on your board, so if you don't have a board, they will expect you to form one. They also want significant oversight of daily operation and are likely to bring in their own management team.

If your company goes public (and the VC may reserve the right to insist on this), the VC will get preferred stock, which is paid out first if you have to liquidate the company.

Finding Angels and VCs

Many entrepreneurs find angels and VCs by word of mouth. You can get recommendations from:

  • Local Chambers of Commerce
  • Lawyers
  • Accountants
  • Banks
  • Other entrepreneurs
  • Economic development centers

There are also websites specializing in connecting entrepreneurs with angels and VCs. Angelsoft.net, Go4funding.com and GoBigNetwork.com are three popular ones. Angel Capital Association provides a state-by-state directory of angel investor networks.

Additionally, there are social functions often held specifically for the purpose of allowing investors and entrepreneurs to meet each other. Attending these events is also a great way to generate interest in your startup.

The Funding Process

Before either an angel or a VC will fund your business, you will have to convince them that it's a good investment and likely to provide a substantial return for the term of the investment. In most cases, this involves making a presentation that offers:

  • A solid business plan that includes your vision for the future and concrete goals along the way
  • Research showing that there is a market for your product or service
  • A financial plan, including an exit strategy for the investor
  • How much money you need to meet your goals
  • How you intend to use the money

Potential investors may also do their own due diligence and competitive analysis.

Angels are usually less formal than VCs and may not need as many specific details. Some might even make a decision after only one meeting. It's still best to be prepared with a formal, detailed presentation.

Some venture capitalists will provide funding in stages, providing the next installment only after predetermined milestones have been reached.

Angels and VCs are both important sources of funding for entrepreneurs, but the appropriate one for you will depend on your company's stage of development and funding needs.