How do you sort through a myriad of investors to find the right choice for your business? Whether a startup or established business, narrowing down the large number of investor to the right types of investors is a crucial step in the capital raising process. The stage of your businesses and growth strategy will largely determine which investors you target. To help you navigate the investor landscape, we’ve compiled a summary of each of the major types of investors in this post.
Crowdfunding is the process of raising small amounts of capital from a large number of individuals in order to achieve a set fundraising goal. Prior to 2016, this method of funding was not used by businesses. In 2016 the SEC (government agency) issued new rules to allow crowdfunding; however, this new rule came with stipulations. There are restrictions on how much capital can be raised, where the transactions can take place and the amount of paperwork required to complete transactions. In short, the SEC allowed crowdfunding, but didn’t make it easy to do so. Christopher Mirabile’s article for Inc. walks through these SEC requirements in detail. Crowdfunding is a still a fledgling industry and most businesses are better off raising funds with other types of investors.
Angel investors are high net worth individuals who invest their personal capital into pre-revenue or seed-stage companies. Not everyone can be an angel investor. In order to comply with SEC regulations, only “accredited investors” or people with $1M in assets or make over $200,000, qualify as angel investors. Angel investing has dramatically increased over the last 10 years and websites like AngelList help match angel investors with startups raising capital. Angel investors typically write smaller check sizes ($25k – $500k), so startups need to sign up multiple angel investors to complete a capital raise.
Accelerators take 5-10% equity stake in a startup in exchange for strategic support, market exposure and sometimes a small amount of funding. Accelerators can be a great resources for first time entrepreneurs who have limited proof points in their business. Like angel investing, the number of accelerators has substantially increased over the last 10 years. Some of these new entrants offer very little strategic value in exchange for equity. If you go the accelerator route, do your diligence on the track record of the accelerator. Two of the larger and more reputable accelerators are Y Combinator and TechStars.
Venture capital firms invest equity in early-stage, unprofitable businesses. Capital is exchanged for equity and is used to fund the operations of the business. Venture capital often follows an angel investment or accelerator program. Venture capital firms invest in the entire spectrum of early-stage companies, from pre-product businesses through larger billion dollar “unicorns.” Venture capital is a high-risk form of investment where the majority of investments lose money or break even at best. To cover these odds, venture capital firms look for high-return opportunities in each and every investment. If your business doesn’t have the opportunity to grow 100%+ a year and be a minimum $100M business, it will be tough to get a venture capital firm interested. Two of the leading venture capital firms are Andreessen Horowitz and Sequoia Capital.
Growth capital firms invest equity in a relatively mature business in order to fund expansion opportunities. Growth capital firms often have a minimum $10M revenue threshold and focus on breakeven or profitable businesses with strong growth trajectories. Insight Ventures Partners and JMI Equity are examples of growth equity firms.
Lower-Market Private Equity
Lower-market private equity firms invest in established and profitable businesses with up to $10M in revenue. Lower-market private equity firms provide owners with liquidity, primarily in the form of an equity investment. Transactions can be total sales of the company, majority investments or minority investments. ROND Capital is an example of a lower-market private equity firm.
Middle-Market Private Equity
Middle-market private equity firms invest in established and profitable businesses between $10M-$500M in revenue (the financial thresholds differs from firm to firm). Investments are usually leveraged buyouts, where a combination of debt and equity is used to buy the business. Cash flows of the company are then used to pay down the debt over time. Like lower-market private equity, partial or full liquidity is generally provided to existing owners. Examples of middle-market private equity firms are HIG Capital and the Riverside Company.
Mega Buyout Private Equity
Mega buyout firms invest in large companies with revenue worth $500M and above. Investments are typically structured as leveraged buyout transactions. Mega buyouts are the majority of big name transactions you hear about in the news, such as Apollo’s $6.9M acquisition of ADT in 2016. Examples of mega buyout firms are KKR and Blackstone.
Mezzanine debt is not technically equity, however, is common in many private equity transactions. It is a form of debt used to replace a portion of the equity in a private equity transaction. Mezzanine debt is typically utilized for a business with steady cash flow and has a high-interest rate. Ares Management is a prominent mezzanine lender
Distressed investors invest in companies either on the verge of bankruptcy or mismanaged businesses. They seek to revitalize struggling businesses by replacing management, rebranding, developing new products, divesting business units and other initiatives.
Infographic on the Different Types of Investors
Once you identify the right type of investor for your business, the next step is narrowing down the pool of investors within your target category. We will have a post in the future to help you evaluate and compare firms. Meanwhile, save down the infographic below as a helpful reference guide for the different types of investors.