Table of Contents
What are angel investors?
What is private equity?
How do angel investing and private equity overlap?
How are angel investing and private equity different?
The bottom line
Sep 12, 2022
8 min read
Angel and PE investments both involve risk, high-net-worth individuals, and are made for the same reason but are two entirely different categories of private investment.
When startups and private businesses need capital to launch or expand, many turn to private investment. Venture capital (VC) is one type of private financing, primarily for tech startups. Angel investing is one of VC investing’s earliest stages for founders to raise capital, which happens before a more substantial Series A round is raised from venture capital firms.
The term private equity (PE) includes all types of private funding options, but is generally linked to PE firms. These private equity firms—ranging from boutique investment firms to global giants—invest in ailing companies with the intention of bringing them back to profitability, before selling the businesses for a profit. While both PE firms and angel investors have a shared goal—to make a large return from investing in a business—that’s largely where the similarities end.
Angel investors are some of the earliest funders in venture capital. For angel investors, these startups that are often just getting off the ground can offer great possibilities for success. Angel investors, or “angels,” typically base their decisions to invest on the business idea, growth potential, the founders’ expertise and professional histories, and execution of the business plan thus far. Investing in startups can be a way for them to diversify their portfolios beyond stocks and bonds.
An angel investor might invest independently with their own funds as a high-net-worth individual, partner with another venture capitalist, or work in a VC firm. Most angel investors are accredited investors.
While the term “angel investor” might conjure images of benevolent financiers fluttering down from the heavens with cash in hand, they are in fact investing in exchange for an ownership stake in the form of equity or convertible debt, which allows them to later buy company shares at a discount. Like other types of investors, the aim is to make a potentially spectacular return—the bigger the better—on their investment. Data on returns is limited and varies. However, research by the Kauffman Foundation in 2017 estimated cash returned to angels at 2.5 times their investment. These investments covered a mean of 4.5 years and produced a 22% return.
Angel investing is considered extremely risky, as the reality of a startup may unfold in an entirely different way than the founders pitched. Angel investors understand that not every startup will be a hit, as “More than two thirds of them never deliver a positive return to investors,” according to the Harvard Business Review.
So, why take the investment risk? Because angel investors are banking on finding that one startup that does succeed with an sizable financial payoff. Angel investor Adam Nash recently wrote in TechCrunch that his 23 angel investments made between 2012 and 2014, had an internal rate of return (IRR) of 48.6% with a value of 21.2x the total cash invested, as of May 2022.
Other notable angel investors include the cowboy shirt-donning Chris Sacca, who invested $25,000 in the once fledgling startup, Twitter, in 2006, one year before the company’s Series A funding round. And ex-Yahoo CEO and current Sunshine app co-founder Marissa Mayer, who has made angel investments throughout her career, including the woman-centered lifestyle digital media company Brit + Co.
Tech accelerators like Y Combinator and Techstars also function as angel or seed investors for young startups. If a young company is accepted into Y Combinator, the fund invests $125,000 for 7% equity plus an additional $375,000.
Private equity (PE) means private financing, but the term often refers to PE firms, which buy mature companies experiencing financial difficulties, restructure them to improve their performance, and later, sell them at a profit. PE firms invest in a wide variety of sectors, from health care and financial services to retail and technology—even local newspapers.
Historically, giant PE firms like KKR & Co. and Bain Capital are known for leveraged buyouts (LBOs), often in the form of hostile takeovers. Using both capital and debt to acquire troubled companies, PE firms often hold a majority stake in the business and control key aspects like cutting jobs, replacing senior executives, and trimming costs by reducing employee benefits. However, there are also PE firms that invest in businesses through growth equity funds, and in such cases, typically take a minority stake. Some PE firms even have a spectrum of funds and services, like a venture capital arm geared for scaling up startups or hedge funds; some firms are also investing in crypto companies.
Private equity investments are considered riskier than public investments bought and sold on exchanges like the New York Stock Exchange (NYSE), but safer than angel investing with its checks and balances. For example, teams of analysts familiar with Wall Street investment banking—many with MBAs—examine every possible data point of a potential PE deal to minimize the possibility of adverse outcomes. The funds formed by PE firms serve as investment vehicles for two types of investors that make up the limited partners (LPs): high-net-worth individuals and institutional investors, like pension funds or university endowments.
Ultimately, the purpose of PE investment is for investors to earn a profit with minimal risk, which varies deal-by-deal. “As of September 2020, private equity funds had produced a 14.2% median annualized return,” according to The New York Times.
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Renowned global PE firms like the Blackstone Group and Thoma Bravo invest in multiple sectors. By comparison, boutique PE firms like Prelude Growth Partners, a growth equity firm, focus on consumer goods companies, infusing them with capital to expand, or scale up. Other PE firms like Arctos Sports Partners invest in the professional sports sector, while multiple PE firms pay hundreds of millions of dollars for music catalogs and master recordings by artists like John Legend and Taylor Swift.
While both angel investors and PE firms want high returns on their investments and are comfortable with risk, there is not much overlap in terms of competition. Angel and private equity investors invest in different stages of a company’s lifespan.
There are more differences than similarities between angel and PE investing.
Angel investors look for extremely early startups; some have not even launched. These early seed investors base their investment decisions on innovative, viable business ideas, founders, and professional track records. PE firms, on the other hand, often look for mature companies in distress to buy, restructure, and sell at a profit.
There are pros and cons of angel investing and private equity, in terms of risk, return on investment, and contributions to society.
If an angel investor is investing as a high-net-worth individual, it can be a very hands-on process. Some angel investors have social good interests—like startups combating food waste, for example—and are considered impact investments for their potentially positive influence on society. Additionally, extremely profitable returns are possible, although rare.
Angel and PE investments both involve risk, involve high-net-worth individuals, and are made for the same reason—seeking a robust financial return—but are two entirely different categories of private investment.
Angel investors invest in the earliest stages of a startup, one that will hopefully scale up and become the next Google, for example. While early investing can be risky (a majority of startups fail), returns on a successful startup can be highly profitable.
Alternatively, PE investments focus on mature companies, often ones that are in trouble or underperforming. Still, these investments are considered safer than angel investments. PE firms typically invest, work to resuscitate, and sell the companies for a profit.
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