Contrary to what many people may believe based on the amount of capital deployed in recent years, the startup investing ecosystem today largely developed only in the last 20 years or so.
Back in the early 00s, startup founders couldn’t count on the financial support of targeted venture firms specializing in investing in early or seed stage companies. The only players funding startups were big, multi-stage venture funds or corporate VC arms dedicated to supporting entire ecosystems around specific products.
This situation began to change over time as specialized VC funds emerged that invested in seed-stage startups. Seed-stage funds were soon followed by pre-seed funds that invested in pre-revenue companies without much traction in the market.
Around the same time, angel investing began taking off as more founders and startup executives began investing directly in startup companies instead of taking a hands-off approach as LPs in funds. AngelList made it easier to syndicate deals and raise smaller investment funds, giving these angel investors extra capital to invest in startups.
Changes to US federal law in the early 2010s, such as the JOBS Act, made it easier for even non-accredited investors to invest in private companies and opened the door for equity crowdfunding platforms such as WeFunder and Republic to emerge.
Currently, it is estimated that the global venture capital investment market is worth USD $347B and will hit a staggering USD $853B by 2027. Suffice it to say that despite the recent turmoils in the market, the VC industry has grown tremendously and will likely keep growing.
In this article, we will shed light on the many different types of startup investors and go into detail on why some invest in early-stage only, while others focus on growth or late-stage companies. Finally, we will go over what the startup investment climate looks like right now for new startups.
7 Types of Investors for Startups
Let’s say you’re a first-time founder looking for financing. You’ve got a great idea that you think can be converted into a great business. You should probably find someone who believes in your vision and write that first check.
Right away, you should know that your options are somewhat limited. Most of the capital waiting to be deployed in startups won’t be available to you. Your startup will get access to bigger investors with deeper pockets only after you have a product in a market generating substantial revenue.
Here are the 7 main types of investors for startups:
- Non Accredited Investors
- Accelerators & Incubators
- Angel Investors
- Startup Syndicates
- Venture Capitalists
- Banks & Institutional Lenders
- Corporate VCs
1. Non-accredited Investors (also known as “friends & family”)
One of the first steps towards raising money for a company is often a "friends and family" round. It can be a bit of a misnomer, as, in many cases, startup founders often raise their first capital from their professional contacts and former co-workers. Be it an acquaintance from work or a wealthy relative, and it might not be the best idea to take their money… unless they are an accredited investor
The process of legally raising money from non-accredited investors is extremely cumbersome since it is subject to more scrutiny from the SEC.
Private companies can get money from private, accredited investors without going through a strict disclosure process and having to report to SEC on a regular basis, which is what a company would have to do in an initial public offering (IPO) to sell its shares to the general public on a stock exchange. Non-accredited investors are, in fact, part of the general public that regulations for private investors are meant to protect.
Rule 506(b) says that an unlimited number of accredited investors and up to 35-non accredited investors can participate in a 506(b)-exempt offering. However, non-accredited investors still have to meet specific requirements in such cases. They have to be an officer of the company that is offering securities to prove that they have enough knowledge about the legal and financial risks of the investment.
It's important to note that your compliance requirements will expand significantly if you only raise money from one non-accredited investor.
Rule 502(b) regulates the disclosure requirements for non-accredited investors, and these include:
- Non financial information like management team, industry, characteristics of the securities offered, third-party broker-dealers facilitating the offering process, and risks involved in offering chosen security.
- Financial information based on company financial statements. These generally depend on the size of the offering. The larger the offering the more extensive the financial requirements.
Startups often do not have these types of financial statements ready as they are rarely making a profit or doing proper GAAP accounting until a few years into the process.
Read more on this topic in our articles: Why Your Startup (Probably) Shouldn't Raise From Non-Accredited Investors and Who Qualifies as an Accredited Investor.
2. Accelerators & Incubators
The goal of an accelerator is to give startup founders access to mentors and other resources to help them succeed.
Each accelerator is a different size, is in a different place, and focuses on different things. However, they all have the same things in common: they are organized by cohorts, and you have to apply to join. Some accelerators are very hard to get into. For example, less than 3% of people who apply to Y Combinator are accepted.
Once a startup is accepted, the accelerator typically invests money into the company for a small percentage of equity. Some accelerators, like Y-Combinator, get up to 20% of the company. Other accelerators do not take an equity stake in your business directly. You might get a grant of between $10,000 and $120,000 to help you work on your idea and get your startup off the ground.
One of the main benefits of doing an accelerator program for startup founders is that these programs facilitate investor introductions and help startups raise their next round of financing.
Many accelerators have a demo day at the end of their program when the latest cohort of companies pitches a wide range of investors. Demo days can help startups get funded quickly and, since they build FOMO with investors, can drive up valuations. YC startups are notorious for getting high valuations after pitching on demo day, sometimes without a product in the market at the end of the three month program.
Not sure if you should join a startup accelerator? Read our article and find out if it is the right path for your startup.
3. Angel Investors
Angel investors are wealthy individuals who invest their money in startups. They are accredited investors, which makes them eligible to invest in startups without extra scrutiny from the SEC. Frequently, they are founders or tech executives with a solid exit under their belt and access to cash. They are looking to put their expertise to work and help other founders build their startups.
Angel investors typically write smaller checks, most of which are between $10,000 and $250,000. Some angel investors, so-called super angels, either have more cash or have raised small venture funds from LPs, enabling them to write more extensive checks of $500k or more. They won't have as many companies in their portfolios because they don't have a big fund to back them up (unlike most VC funds).
Still, having individual angel investors on your cap table can prove to be very helpful. Because they are operators with deep connections in the industry, angels often serve as a conduit for intros to investors, potential business partners, advisors, and other people who have the expertise you need to make your startup succeed.
Want to find out more about angel investors? Check out our article on How to Find the Right Angel Investors for Your Startup.
4. Startup Syndicates & SPVs
Syndicates are a quick and easy way to get money for your new business. You can raise money from many different investors without having each investor directly on your cap table. This cuts down on the legal paperwork required in future financing rounds or acquisition deals.
Syndicates can also connect you with an extensive network of backers from different backgrounds and skills. This can be useful for you as you can get a lot of help and advice, but it carries some potential risks as you may accidentally leak information to competing companies.
A special purpose vehicle (SPV) is a group of people who come together to make one investment. The SPV is an LLC that was formed for the sole purpose of making an investment into a startup. Assure, AngelList, and other platforms can help you set up an SPV for pooling investors into your startup.
Most investments in a syndicate are high-risk and high-reward. Backers are typically pre-approved and have had their accredited investor status verified. At the same time, syndicates make it possible for investors to back many deals with small amounts. AngelList enables investors to contribute as little as $1,000 to a syndicate.
A lead investor is in charge of each group of investors. Usually, the syndicate lead is a part-time investor with experience in the startup world and a track record of successful investments.
Syndicate lead makes most of their money by charging carry. Carry is a share of the profits of the syndicate. How much a lead takes in carry is agreed upon with their investors. On AngelList, 20% is a typical carry rate for syndicates.
Find out more about startup syndicates in our article: What is a Startup Syndicate and How Does it Work?
5. Venture Capitalists
VC funds are pooled investment vehicles typically composed of private equity that target seed and early-stage startups with high-growth potential.
There’s a couple of important things for founders to understand about VCs and VC funds.
- Investment strategy - VC funds’ investment strategy involves targeting a large number of high-risk and high-reward opportunities and investing small (relative to the fund’s size) sums of money in hope of “hitting the jackpot” when one of their portfolio companies achieves high growth. Such company could yield returns far greater than the initial investment, or even entire investment portfolio.
- Structure - VC funds have a specific structure. At the very top are the Limited Partners (LPs) who provide the fund’s capital. They are the investors in an investment vehicle. General Partners (GPs) are the most senior people in the firm, and they make the final decisions about the investments. They also may sit on the board of the directors of the companies they invest in. Partners are people employed by the firm to oversee a particular stage of the investment process like due diligence or deal sourcing. Principals or directors are junior deal professionals who have some responsibility in making the deal happen, but can’t make investment decisions on their own. Associates work for more senior people in the firm and assist them in the scouting for new deals and helping with other parts of the process.
- Life cycle of a VC fund - Venture capital funds have a long investment horizon, meaning a venture fund is typically expected to yield returns after 10 years (sometimes funds’ life can be extended by 2-3 years to distribute the assets). First 1-3 years are the initial investment phase, when VCs are looking for the right companies and deploying the capital. Phase two is growth phase, when investors support and offer guidance to their portfolio companies in hopes they achieve high-growth. Phase three is all about helping the company go public and harvesting the returns, in case an IPO actually happens. Big exit is the holy grail of a VC, but for many companies - it never happens, as they fail or get acquired along the way.
Interested in finding out more about the venture capital world? Learn How venture capitalists make money and What Startup Founders Need To Understand About VC Limited Partners so you can better understand your funding opportunities.
6. Banks & Financial Institutions
Most early-stage startups have a hard time getting money from traditional banks. However, the role of an investment banker makes sense for a startup in the later stages of startup development, when a company is looking to raise $50 million or more. Bankers are also useful in deals that require a partial recapitalization, for example, when a company has to go through restructuring of its debt and equity, as a result of getting a deal with a private equity firm.
It’s also worth noting, although it is not technically investing, that as your business grows, banks may offer you business credit cards, credit lines, and venture debt financing consisting of term loans.
How does this work?
Unlike venture capitalists who provide funding to founders in exchange for shares in the company, venture debt lenders loan money to startups without taking their equity.
And unlike a conventional small business loan, debt financing is restricted to entrepreneurs whose companies have already received venture capital funding, i.e. a financing round. Debt finance can supply working capital-required startups with cash flow.
Private equity firms, hedge funds, banks, and company development corporations are the providers of venture debt (BDCs). The average period for a venture debt loan is three years, and it is senior debt, which must be repaid before to any other debts the borrower may have.
7. Corporate Venture Capital
Corporate venture capital (CVC) is a subset of venture capital that involves large companies investing corporate funds in small and nimble startups to acquire their talent or technology in order to gain a competitive advantage.
How does one differentiate regular VC from corporate VC? Corporate VC consists of one specific fund that gets its capital from a large company (like Google or Salesforce) and is not managed by a third party.
Corporate venture capital is all about mutual growth. Startups can often innovate and ship products faster than large corporations because they’re more nimble and can more quickly adapt to changing market needs. What startups often lack are funds and connections to institutional partners in their target industry - something that a large company can provide to startups to help accelerate their growth.
Corporate VC is a fairly broad undertaking and typically only larger corporations set up venture arms. It all depends on the needs and financial objectives of the corporation. CVC investments span from the early-stage financing through capital expansions all the way to IPOs. The top sectors for corporate VC investments are biotech, software, telecommunications, semiconductors and media/entertainment.
- There are many ways to get financing for your startup, but only some of them will be available to first-time founders who have just started their first company
- As you grow your business and your network, you will get access to more fundraising opportunities
- Understanding the differences between startup investors and knowing which ones are the most likely to fund your company is essential in running a successful startup
- Once you get your company to the later stages of its growth you’ll likely start looking at options like taking your company public in an initial public offering or getting acquired by another (possible much larger) company.
Written by Michał Kowalewski
Writer and content manager at Capbase. Passionate about startups, tech and multimedia. Based in Warsaw, Poland.
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