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Angel Investors vs. Venture Capital vs. Private Equity: Key Differences

October 17, 2022
8
min

When discussing investments, all three can fund startups and get paid out if the company is sold or goes public, these funding types have distinct differences.

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There are many types of investors who offer money to businesses seeking funds to grow, and the differences between them can be nuanced. When talking about startups in particular, the terms “angel investing,” “venture capital,” and “private equity” are often erroneously used interchangeably.

The misconception is understandable: Angels, VC funds, and PE firms may all invest in startups in exchange for stakes in the company, and they tend to make money only in the case of an event like a sale or stock market debut of the company. 

But these structures also differ in key ways—including at which point in the business lifecycle the investors invest, the entities involved, and which types of companies the investors focus on.

What are angel investing, venture capital, and private equity?

Angel investing, venture capital, and private equity are all forms of investing that help a company grow, and typically invest during different stages of business.  

Angel investing

This form of private investing happens in the very early stages of a new business, in which individuals fund the company with their own money. These angel investors might be high-net-worth individuals or friends and family of the founder(s). This type of investment, sometimes part of a pre-seed or seed round of funding, is riskier because the companies are very new and may flounder or fail. In exchange for taking that investment risk, angels typically receive equity in the business—which could pay big dividends if the company succeeds and is sold or completes an initial public offering (IPO).

Venture capital

Often abbreviated to VC, venture capital is a catchall term for funding provided by investment firms to privately held companies that the firms believe have potential for growth. This funding is typically raised in rounds, and VC firms often come in after the seed stage—in rounds called Series A through D (or beyond). Again here, venture capital firms typically invest in exchange for equity and would profit through a sale or IPO.

Private equity

Private equity firms are investment management companies that raise billions of dollars every year from both wealthy individuals and institutional investors. They may offer capital to any type of company that needs cash: private or public, startup or established. Businesses may turn to PE as an alternative to high-interest bank loans or time-consuming IPOs if they are struggling and need cash flow or are seeking funds for growth or expansion. 

For financially struggling companies or businesses that are long-established, the PE firm often executes a leveraged buyout (LBO), using debt to make their equity investment go further. After PE firms invest in a company they usually look to improve the company and exit the investment within three to five years through a sale or IPO. They can also make money through management fees and performance fees.

How similar are angel investors, venture capitalists, and private equity firms?

All three of these investor groups are similar in that they seek to fund companies they believe have potential, and they may choose to invest in startups in particular. Some investors in each category may also offer companies intangible resources like their expertise and professional networks. Additionally, in each case the funding doesn’t have to be repaid like a traditional loan. Instead, the company will have to share profits with its investors during an event like a sale or IPO. 

How different are angel investors, venture capitalists, and private equity firms?

These investor groups have important differences, however.

Stage of business

Perhaps the biggest differentiator is at which point in a business’s life cycle the investment is made. An angel/seed round of funding happens at the earliest stage of a startup to help get the company off the ground, which is why angels sometimes have personal relationships with the founder(s). Some wealthy individuals may also participate at this early stage, particularly if the founders have been successful before.

Venture capital funds typically start to come in after the seed stage when the company is at least a bit more established, with financial data and future plans to share—though often the company is not yet profitable. One or a few VC firms may lead the rounds of funding, which begin with Series A and B. It’s usually after that point—in Series C and beyond—that PE firms may also get involved, joining late-stage venture capitalists in continuing to fund the company after it establishes a track record of growth.

PE firms don’t only invest in startups, however. Beyond providing funding to early-stage businesses, private equity funds may also provide cash to more mature companies looking to grow—or complete a leveraged buyout of an established company altogether.

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Team of investors

Another crucial difference is how each investment group is structured. PE firms are highly structured and are composed of two partner groups. General partners manage the fund, own a minority share, and have full liability. Limited partners are usually entities like wealthy individuals, pension funds, or foundations, and they own the majority of the fund with limited liability. Once the fund reaches its financial goal, the partners close it and invest the money into the company in question. The PE firm may also make operational or management changes.

VC companies usually follow a similar structure with general and limited partners. VCs may take a board seat in their portfolio companies, but they typically have limited involvement in running the business. Angel investors, by contrast, tend to be high-net-worth individuals or groups of individuals, and the funding comes from the angels’ own capital. Like VCs they may offer the startup advice and support, but they don’t manage the company.

Size of investment

Angel investing usually doesn’t require a minimum investment amount, as early companies are looking for backers willing to fund a startup without an established track record yet. A founder and family members may invest $10,000 each; a wealthy angel investor or angel fund might be willing to kick in hundreds of thousands or even over $1 million.

The VC stage can vary widely, too, depending on the size of the fund, the valuation of the company, the growth potential of the industry, whether it’s a Series A or C round, and many more factors. Speaking generally, VC deals tend to be in the millions and can reach tens of millions. Finally, because PE firms tend to come in later when the company is already established, these deals are often larger: typically in the millions, and even billions in the case of huge firms like Blackstone.

Type of investment

Angel investors and VCs alike may invest for an equity stake in the company. They might also invest in exchange for convertible debt, in which the startup receives the funds but delays valuation until a later time—usually a funding round like a Series A. At that time, the company is valued and the debt is converted to equity for the investor.

Another investment option for angels and VCs is known as a simple agreement for future equity (SAFE). This is an agreement between a company and an investor, in which the investor receives the right to purchase stock in a future funding round at a pre-determined price and parameters.

PE firms also invest for equity, but often through a different structure. In a leveraged buyout, the PE uses its own equity plus lots of debt, or leverage, when buying the company. They aim to maximize the company’s efficiency and profit, sometimes making major changes to operations and management, and turn it around for a sale or IPO that may offer a high rate of return.

Percentage of equity

Angel investors typically ask for equity stakes of at least 20% in the companies they fund, as they generally take the most risk given that they invest in the earliest stages. 

The size of VCs’ ownership stakes can vary by deal, sector, and funding round. Crunchbase analyzed 105 tech companies at the time they went public and found that when adding up all of the stakes from VC firms that invested, they owned a median of 53%. PE funds often acquire majority stakes to assume control of the company, up to 100% in the case of a full buyout.

The bottom line

When discussing investments in startups and other companies, the terms angel investing, venture capital, and private equity are often used interchangeably. Although all three can fund startups and get paid out if the company is sold or goes public, these funding types have distinct differences.

Angel investors typically fund a startup in the very early stages using their own personal capital, usually ranging from thousands of dollars to about $1 million for a 20% stake or more. Venture capital is typically raised in rounds from investment firms with general and limited partners, for a median 53% stake by the time of a startup’s sale or IPO. Private equity firms are investment management companies that raise funds to purchase majority stakes or full buyouts of mature companies—often assuming control of them with the goal of an exit within three to five years.

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