What are the Different Types of Investors?

Understanding the different types of investors is an important part of the investment process. The basic concept is that the type of investor that you seek should be the right one for your stage of business (pre-revenue, revenue, growth stage) and for the amount of money you are seeking. We outline the major types of investors and the general rules for what stage they are best for and how much they look to invest. While these are not hard and fast rules, they should help in your investment process.

“Understanding the different types of investors is an important part of the investment process.” 

Friends and Family

Friends and family invest the most money in startups in aggregate, investing over $60BB per year. In fact, 38% of startup founders report raising money from their friends and family. The average amount invested is $23,000. Seeking investments from friends and family can be an ideal way to raise seed money to get your company off the ground. Keep these things in mind:

• Future Potential. This group can also be a great resource for very long-term investments, motivated more by loyalty and support than by strict return on investment. These close circles generally consist of the individuals most likely to feel a strong affinity for your brand — or, simply, to you.
• Documenting. It is of the utmost importance that all investments are thoroughly documented.
• Know the Risks. Mixing business with pleasure is notoriously risky, and for good reason. Before taking their money, do some soul-searching to be sure that your ties are strong enough to withstand the worst. By accepting their investments as you launch your company, you risk hurting your loved ones’ finances. It is imperative that all parties are on the same page, literally and figuratively.
• Stage. Friends and family are best used only at the beginning of a company, when there are little or no alternatives available. They also make sense for very long-term investments motivated more by friendship or family than by strict return on investment. They might also provide the earliest seed money for companies that grow and receive other investments later on.

Angel Investors

There are an estimated 268,100 active “angel” investors in the United States. They invest an estimated $20 Billion into 60,000 companies a year. On average, they invest $74,955 into companies. An angel is a high net worth individual who invests directly into promising entrepreneurial businesses in return for stock in the companies. Things you should know about angel investors:

• Who are They. Many angels are successful entrepreneurs themselves, as well as corporate leaders and business professionals.
• How They Help. Angels can be an ideal fit for start-ups, because their personal interest in the healthy growth of the business, and their own litany of past successes and failures often prompt them to act as mentor and coach to their portfolio companies. This can include introducing the entrepreneurs to potential customers and investors, identifying and advising on potential problem areas, and generally helping the startups gain credibility and recognition in their industry.
• Angel Groups. Angel groups are organizations formed by individual angels interested in joining together to evaluate and invest in entrepreneurial ventures. This scenario allows angels the ability to pool their capital to make larger investments. As of 2019, there are over 400 American angel groups on record in the Angel Resource Institute database. There’s a huge range with angels in how sophisticated they are about analyzing a business (called due diligence) before they invest, and what sort of terms and deals they’ll take. They tend to pool together tens of thousands of dollars to invest a larger sum of hundreds of thousands of dollars, rather than tens of thousands or millions.

Venture Capital

In 2018, VCs invested almost $100B in startups. VCs write the biggest checks of the four investor types, with an average investment size of $2.6MM to seed stage companies. Venture capital firms are in the business of reviewing, assessing, and investing in new and emerging businesses. Things you should know about venture capital firms:

• They See a Lot. VCs look at a very high volume of deals, and on average only invest in 1 out of every 100 deals they consider — compared to angels, who invest in 1 out of every 10 deals.
• Due Diligence. Furthermore, VCs conduct significantly more due diligence than angel investors, spending an average of 5 months on due diligence for each investment.
• They are Active. While angels will occasionally act as mentors to the entrepreneurs they bankroll, venture capital is consistently an active, rather than passive, form of financing. These investors seek to add value, in addition to capital, to the companies in which they invest, both to help your company grow and to achieve a greater return on their investment. This means active involvement: virtually all VCs will want a seat on the Board of Directors.

Crowdfunding

Crowdfunding is by definition, “the practice of funding a project or venture by raising many small amounts of money from a large number of people, typically via the Internet.” There are four distinct types of crowdfunding:

• Rewards-based crowdfunding: In rewards-based crowdfunding, backers contribute typically small amounts of money (typically between $1 and $1,000 but sometimes more) in exchange for a reward. This reward is often, but not always, the item being produced, such as a watch, an album or a film. Kickstarter and Indiegogo are the two most popular rewards-based crowdfunding platforms but there are LOTS of other platforms.
• Donation-based crowdfunding: In donation-based crowdfunding, donors generally donate small amounts (again, typically between $1 and $1,000, but sometimes more). There isn’t always a reward beyond the gratitude of the project creator or beneficiary (and possibly a tax deduction). It is typically used to raise money for a non-profit or a cause, like drilling a well or building a school in Africa or for a personal campaign like an individual’s treatment or medical bills. GoFundMe and Crowdrise are two popular donation-based crowdfunding platforms but there are lots of others.
• Equity crowdfunding: In equity-crowdfunding, investors give larger amounts of money (at least $1,000 and often a lot more). When investors give the money, they don’t get a reward, but instead, a small piece of equity in the company itself. As a result, equity crowdfunding is typically used to raise money to fund the launch or growth of a company, not just initiate a creative project or cause. Often, these companies go on to raise money from angel investors or venture capitalists. AngelList and Crowdfunder are two of the most popular equity-crowdfunding platforms in the United States, but there are lots of others. Fundable, EarlyShares and CircleUp are other popular platforms in the U.S. and and Crowdcube and Seedrs are popular in the U.K. and Europe.
• Debt crowdfunding: In debt-crowdfunding, it’s not “backers” or “donors” who give money, but lenders. Unlike other forms of crowdfunding, it’s NOT an exchange for a reward or equity. The investors don’t get a reward and they don’t get a piece of equity in the company, but instead they make a loan with the expectation to get paid back the principal plus interest. So it’s a lot like loan from the bank, but instead of borrowing one larger amount of money from one bank, you borrow smaller amounts of money from multiple people. Debt-crowdfunding can be used to raise money for lots of reasons, like credit card refinancing, debt consolidation, home improvement, a car or other reasons.

With very different terms and requirements, it’s necessary to understand the nuances involved with each branch of crowdfunding so as to choose the path most relevant to your goals and needs.

Other Sources

Other sources of capital you may consider:

• Customers: Customers include both existing and prospective users of the startup’s product or service. These investors tend to have strong pre-existing knowledge of the startup and its product or service, and their close connection with the business can make them fans, advocates, and brand ambassadors.
• Corporate Venture Capital: Some large corporations may choose to make early-stage investments through a corporate venture capital division. These investments may be intended to provide strategic advantage in the corporations industry through the acquisition of emerging technology and talent, or to diversify the corporation’s interests.
• Family Offices: A family office invests funds on behalf of high-net worth individuals or an extended family of high-net worth individuals. Family office funds may be managed by a multi-family office which manages funds for several families, a single-family office which focuses on a single family or self-managed by a member of the family.

There really is no optimal type of investor – it all depends on your stage and your needs and what an investor can bring to the table in both capital and other help they can bring your business.