Investing in startups is an exciting and potentially lucrative way to get involved in the world of business. Two common ways to invest in startups are through venture capital (VC) firms or as angel investors. Understanding the similarities and differences between the VC and angel investing processes can help you determine which approach is best for your individual needs and goals. In this article, we will explore the key aspects of the VC and angel investing processes and learn from perspectives shared by veterans in the industry.
A big thank you for this article goes out to venture capitalists Romain Diaz (Satgana), Jan Sessenhausen (Cusp Capital) and angels Kutlu Kazanci, Morten Helgaland, Nicholas Richards, James McClure and Matthew Stafford that were sharing a bit of their wisdom for this article with us.
These stages may vary slightly depending on the specific VC firm, but generally include the following:
Potential investment opportunities are identified by attending conferences, networking events, and meeting with entrepreneurs and industry experts. Romain Diaz, Founder & CEO of Satgana, a climate tech VC firm, adds that opportunities can also be sourced passively through an application form on a website to ensure relevant data is collected in a uniform and harmonized manner.
The long list is narrowed to identify start-ups that fit the firm's investment strategy and criteria. This may involve reviewing the company's pitch deck and financials, conducting market research, and assessing the potential risks and rewards of the investment. Romain Diaz notes that 20% of companies get a call from Satgana. Jan Sessenhausen, GP at Cusp Capital, a VC investing in software and sustainability start-ups, adds that “initial contact with a company is typically one team member having a 30 minute call, afterwards we expand our “deal team” to two team members if we are interested in diving deeper.”
If the investment opportunity passes the initial screening, the VC will conduct a more thorough due diligence process. Jan Sessenhausen adds that “throughout the process we phase in different people from our team who look into specifics they are experts in, e.g. Finance, HR or ESG topics. The deal team is responsible for providing the larger investment team with continuous updates regarding learnings, progress etc.”
The term sheet will outline the key terms of the investment, including the amount of funding, the equity stake the VC firm will receive, and any conditions or requirements associated with the investment. Romain Diaz states that he typically has 5 or more calls before making an investment decision. Jan Sessenhausen notes that “it is important for us to get a thorough understanding of the founding team, the status, and plans for the business before giving out a Term Sheet, as such this process often takes up to 4 weeks”.
Jan adds that “this is also helpful for founders to get a good feeling for us as a potential partner to be working with for the upcoming years.”
If both the VC and the entrepreneur agree to the terms outlined in the term sheet, Romain Diaz notes that it will go to
“legal for contracting and compliance for AML checks. With the term sheet, compliance sheet and investment memo complete, it is submitted to the board for approval before the funds are wired”.
Broadly the stages are similar to a venture capital firm but there are differences in how the earlier stages are executed. Below we look at the approaches taken by 4 angel investors.
Angel investors may find potential investments through personal networks, referrals, online platforms, or by attending pitch events and conferences. A few examples are:
Morten Helgaland: “I almost never say no to a meeting request. I do however explain that I have certain preferences when investing and if they don't meet those preferences it may be too much work to convince me to invest.”
To determine if the investment fits their investment criteria, angel investors review the company's pitch deck, financial statements, and other relevant documents. In the words of some angel investors:
Nicholas Richards: “When I think of the start-ups I’ve invested in over the years, what they’ve all had in common is articulating the problems and solutions with absolute clarity, so even a non-expert can understand.”
Matthew Stafford: “I have a Golden Rule for this: ***If I meet you for the first time and you are raising investment then I will not invest in this round***”
At this stage, the angel investors assess the company's potential for success. This may involve reviewing the company's business plan, market analysis, competitive landscape, and management team. Due diligence may also include speaking with customers, suppliers, and industry experts.
“I hope to get to know the founder … I look for the right combination of grit and self-awareness. A pitch deck is a sales document and it doesn't tell me [that] so that's why I don't invest when I first meet someone … The chances are they'll need more investment in the future … So if the founder comes to 9others and we get to know each other then when they do want to raise again I'll know whether I want to invest and they'll know whether they want me as an investor.”
Nicholas Richards: “If the deck is interesting I’d want to have a conversation with the founder to understand more about where they want to take this, and also understand their personality and motivations, which will be key to execution of the vision. If I have network contacts in this space, I'll ask them about what they think and why. I’ll trial the product myself if possible (and competitors’ products), I might question TAM figures, interrogate financial models etc. - I’m not necessarily looking to expose holes, so much is uncertain at this stage, but I love these question exercises to understand how much the founder has thought about this and, to be honest, how well they can tell it. If time permits, I like to write up my own little investment memo.”
This may involve determining the company's valuation, the amount of equity the angel investor will receive, and any other terms and conditions of the investment.
Once the terms of the investment have been agreed upon, the angel investor and the company will typically finalize the investment by signing legal documents.
Angel investors and VCs have different investment criteria. As high net-worth individuals investing their own money, angels may invest in a wider range of companies than VCs, be more willing to take on higher-risk investments, and may seek opportunities to be more hands-on with their investments. Angels may also invest for personal reasons, such as supporting an industry or backing an entrepreneur. On the other hand, VCs are professional investment firms that have more structured investment criteria. They often invest in later-stage startups with a proven business model, revenue growth, and a larger market opportunity.
The majority of angel investors interviewed for this post mentioned that they invest at seed or pre-seed.
For Nicholas Richards, things that are particularly important at pre-seed and seed are
Matthew Stafford adds:
On the other hand, James McClure grounds his assessment using an established framework: “I use a framework developed by Paddy from Odin, here's his original example - this scorecard helps me calibrate.”
Finally, Morten Helgaland highlights the subjective criteria used to decide: “I need to get a good gut feeling. Do I trust the people? Do I really believe it? This is more of a subjective thing - and also where most companies fall off my process.”
On the other hand, VC investments are more structured. As Jan Sessenhausen, GP at Cusp Capital explains, their investments are driven by their four theses: “industry-specific software”, “underserved online lower-income consumers”, “digitization and sustainability” and “European digital infrastructures of global relevance”.
Finally, a subjective element which is the “vibe with the team” or the “human touch” is also checked off.
A critical factor influencing this is the investment size. Angel investors may invest small amounts of money, typically ranging from tens of thousands to a few hundred thousand dollars. VCs, on the other hand, may invest larger amounts, ranging from a few million to tens of millions of dollars.
That said, risk management varies greatly among angel investors and VCs.
Matthew Stafford manages risk through his extended due diligence process shared above (where he spends time getting to know the founder), diversifying his investments outside start-ups and using the Seed/Enterprise Investment Scheme (S/EIS) tax breaks available in the UK. From a rewards perspective, the question here is if the valuation can be 100x.
Similarly, Nicholas Richards tries to diversify but states, “If an investment is weaker in certain areas, [it’s] important for me that the founding team acknowledges the ‘challenges’ of the opportunity, and I can see evidence of the hustle, grit, and adaptability that’s needed to power through these. Aside from the team, it’s important to me the startup has an early ‘area of excellence’, i.e., something which stands out already and the startup can leverage already to help them get traction. With my startups to date, those ‘areas of excellence’ have been market, product, and distribution.”
In contrast, James McClure takes a more clear-cut approach: “I only invest at pre-seed/seed, so it's heavily focused on "can this business 100x". I balance risk by not investing in areas I don't understand, which doesn't mean I'll be successful - but that helps me at least understand the risks”
Finally, Morten Helgaland doesn’t consider risk: “in a quantified manner on unlisted, early stage, assets. It is beyond my capabilities, and I don't think I would get a better portfolio because of it anyway.”
Similar to Morten, Jan Sessenhausen explains, “We do not consider ourselves to be “risk managers” – we aim to go for opportunities together with the teams we invest in. As such, we focus on the potential upside (reward) and potential relevance for overall fund performance, instead of creating an extended list of risks that could go wrong.”
In contrast, Romain Diaz, takes a more balanced view: “each company is plotted on a risk/reward matrix, and the portfolio is balanced accordingly. The portfolio comprises deals that will 100x but do not have a high chance of succeeding and companies that will not return funds fully but have a low likelihood of failure.”
Angel investors and VCs have more similarities than differences in making this decision, relying on a combination of objective criteria and subjective assessments to come to a conclusion. That said, the number of times VCs turn down investments is far greater than angel investors.
Nicholas Richards highlights the objective elements here: “Fail to see how it can be a huge company either due to market size, lack of ability to differentiate or most importantly struggling to understand how the company will ever get product-market fit.
Likewise, James McClure uses objective criteria to make a distinction between products that can inherently scale, and he will invest in vs. services: “There's a difference between a product I love as a consumer and one that's a good investment; I found that with a consumer app in the childcare space. I really wanted to invest as it was a great service, but ultimately it was a service, not a product - which meant the scalability wasn't there for a huge return”.
After considering the objective criteria, “gut feeling” is a key differentiator for Morten Helgaland: “Twice recently I've said no because I couldn't understand the market and its mechanisms - even after believing in the product. In both cases, I was also uncertain about my trust in the founders. For me, it comes down to the gut feeling in most cases when I reject something I theoretically believe in.”
Matthew Stafford also exemplifies this: “Often there's something in my gut that makes me pause. If I'm not charging ahead with the deal, then maybe there's a reason I'm not charging... So I pause and try to figure out what that reason is. For me, that's mainly about the founder - them as a human - perhaps we don't click, perhaps I think I might not have an open relationship with them, etc. That's not to say they won't be successful, but I want to be able to be candid and transparent with founders.”
Jan Sessenhausen explains that they turn down investments daily. Romain Diaz expands that a deal can be turned down for anything from the market size or people fit: “for example, the start-up can have a commercial impact, but the team is arrogant; for others the valuation is unjustified, but the other bits like team and product are great.”
Across angel investors and VCs, the view is to hold investments for the long term until they are fully acquired, or an opportunity presents itself much later in the company’s life in the secondary market.
The angel investors we interviewed all had a preference to hold on to their shares till they were bought out:
Jan Sessenhausen notes “they are usually long term commitments and so exit paths are not discussed in much detail. Afterward, it is mostly an opportunistic approach (in alignment with the founders and other shareholders) ... the most attractive opportunities we’ve been involved in were initiated by an interested (potential) buyer … mostly as a result of strong operational development and resulting market recognition of the company.”
The investment processes for venture capital and angel investing broadly follow the same approach: they involve finding potential investments, conducting due diligence, negotiating terms, providing ongoing support, and eventually exiting an investment. However, there are differences in how investments are sourced, the investment criteria used, the size of the investment, the stage at which investments are made, and the risk management. Both investment processes offer unique advantages and drawbacks, and the decision of which to choose ultimately depends on your needs and goals.