From investing in early-stage startups to big-name private companies, here's the difference between angel investing, venture capital, and private equity.
Updated Feb 14, 2023
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Investing in public companies is easy—just open up your favorite roboapps and start buying stocks. It's also relatively safe, at least compared to many other, more volatile investments. But you're not looking for easy, are you?
If you're interested in angel investing, venture capital, or private equity, you're probably looking to take on a little risk in hopes of a higher reward. All three of these fit the bill to varying degrees.
From investing in startups to buying out larger private companies, angel investing, venture capital and private equity are three of the most popular ways to get involved in potentially lucrative private markets. Here's what you need to know about the risks—and rewards—of each type of investment.
Angel investing, venture capital, and private equity are all different ways of investing in private (non-traded) companies. Josh Womack, Investment Advisor and Fund Manager for Womack Capital Partners, has done all three. He characterizes them as a ladder: As you climb the ladder from angel investing to venture capital (VC) investing to private equity, you're looking at investing in progressively more mature companies. This means you're taking on less risk—and also targeting more moderate returns.
Angel Investing | Venture Capital Investing | Private Equity Investing |
|---|---|---|
Invest in very early-stage startups that often have no customers or revenue | Invest in early-stage startups that have some revenue and/or customers but usually aren't yet profitable | Invest in mid- to late-stage private companies that are typically profitable and have been operating for years, if not decades |
Highest risk | High risk | Moderate risk |
Highest potential returns | High potential returns | Moderate potential returns |
$10,000 to $500,000+ per investment | $1 to $5 million minimum | $250,000 to $25 million minimum |
Womack explains why he moved up the pre-IPO investing ladder in this fashion. "I started learning that while the startup world is really fun and exciting, and it's sexy to be in that early-stage company, it's really hard to pick winners in that space. The stats bear that out." So eventually Womack started exploring VC investing with companies that were already generating a couple million in revenue, and he found that being able to see that history of growth made his investments a little more predictable.
But he didn't stop there. Eventually, Womack moved into private equity, investing in profitable companies that have been around for 20 years or more. "You can look at those and be like, 'Wow, they made it through the '08-'09 recession. They made it through the last decade or so, and here's how they performed.' That data is really powerful," he explains.
However, that's not to say that you always have to move through these three forms of investing in private companies in that order, and it's also not to say that private equity is better than VC and angel investing. They're simply different, each method with its own set of pros and cons. Private equity is often more stable, yes, but it also won't give you the rush that picking the right startup and managing to 100x your money will.
Back in 2010, angel investor Mike Walsh invested $10,000 in Uber back when it was still called UberCab—his $10k is now worth tens of millions of dollars. The company was valued at $4 million during this first round of funding when Walsh invested. By 2019, when Uber went public, it was valued at $80 billion.
An angel investor is someone who invests in early-stage startups before they've generated enough revenue or customers to attract other types of investors. This makes these investments extremely high risk and hard to predict, but because they're getting in on the ground floor, angel investors can see massive returns on startups that achieve high growth and a successful exit.
Angel investors are usually accredited investors, but they don't necessarily have formal financial training or a professional background in finance. Many are entrepreneurs or startup founders themselves who simply have enough money to invest and have a knack for working with startups. You can find deals through online platforms like AngelList, through your personal and professional network, or by joining an angel group.
Angel investors invest their own money, and they'll invest anywhere from $10,000 to $500,000+ in a startup. A typical angel investment amount is $25,000. Given that you'll probably want to invest in at least 10 different startups to properly diversify your portfolio, you'd need at least $250,000 to get started.
Angel investors invest in very early-stage companies knowing that many will fail, but in the hopes that the few that succeed earn them high enough returns to more than make up for the ones that go to zero. They'll typically invest across 10+ different startups to balance the risky nature of early-stage startup investing.
Angel investors usually aim to see returns within 5 to 7 years. There are various ways to exit, which include: the company buying back your stake, being bought out by a VC investor in a later stage, the startup being acquired by a competitor, and the startup going public with an initial public offering (IPO).
Startups
A venture capitalist is someone who invests on behalf of a VC firm in startups that are typically at least in their Series A funding round. Unlike angel investors, VCs don't typically invest in startups that are still in the very beginning stages of their journey. They're often still looking for high-growth potential, early-stage startups, but they want to see some track record in the form of revenue generated and/or a growing customer base.
Most VCs are accredited investors. You typically need to become a partner at a venture capital fund to start VC investing. To do this, you'll either need to have a proven track record as an angel investor, entrepreneur or startup executive, or you'll need to join a VC firm at the bottom (say, as an apprentice or intern) and work your way up to partner. For individuals who aren't already wealthy, the latter is generally the only route to becoming a VC.
Since VCs usually invest in startups that are a little further down the line than angel investors, investment amounts are higher. However, you're investing money from a pool of investors as part of a VC fund rather than investing your own. You'll probably need to raise at least $5 million to $10 million for your first VC fund. More established VC funds manage $100 million or more.
Like angel investors, VCs are still investing in fairly high-risk companies and thus look to diversify their fund. Small VC funds will invest in at least 10 startups, but most invest in 20+ at a time. Usually, these funds spend the first few years actively investing in new startups and aim to return all capital to investors within 10 years.
In most cases, VCs will look to exit either through an acquisition or an initial public offering (IPO). Many startups already have a plan in place for whether they aim to be acquired by a competitor in their industry or to eventually go public, and often VCs can advise startups on which strategy to pursue.
In the early 2000s, Hilton Hotels was raking in revenue and expanding across the globe, but they needed support to continue with such rapid growth. Blackstone Group completed a leveraged buyout of Hilton Hotels in 2006, investing $26 billion into the private equity deal. The real estate bubble in 2007 and the financial crisis in 2008 left the hospitality industry in hot water, but Blackstone was able to help Hilton Hotels come out on top with some clever debt restructuring and strategic growth moves. In the end, Blackstone profited $14 billion off the deal over the course of 11 years.
Private equity is a form of investing in mature private companies or, sometimes, buying out public companies and taking them private in order to restructure. Typically, private equity firms look for companies with a high profit potential that are struggling with an issue they believe they can correct. Leading alternative investments firm Blackstone's private equity portfolio includes such well known companies as Ancestry and Bumble.
You can invest in private equity through a private equity fund, but you have to be an accredited investor with a good chunk of change to spend. In most cases, you'll either need to be a high net worth individual or an institutional investor, such as an endowment or fund.
Many private equity firms require clients to have at least $25 million available to invest in order to invest in private equity. However, there are some firms with investment minimums as low as $250,000. You'll also have to pay sizeable fees of about 1.5% to 2% of assets under management.
Private equity firms target mid- to late-stage companies that are struggling to achieve or maintain profitability but show great potential for growth. They often take a controlling stake of 50% or more and use that to restructure the company and maximize efficiency and profitability. Often, they do this through what's called a leveraged buyout (LBO). In these deals, a private equity firm takes control of a company through a combination of equity and debt financing, and as the company achieves profitability, they pay back their debt (and said equity increases in value).
There are many different exit strategies for private equity investors. They may exit through an IPO if the company goes public, or the company's management may decide to buy back their shares. Private equity firms can also sell their shares to another private equity firm or to a third-party purchaser (known as trade sales).
While you usually need to be an accredited investor to invest in private markets, new crowdfunding platforms like MicroVentures let just about anyone invest in startups. You can browse their website to pick a promising startup and invest as little as $100. The value of your equity will go up or down according to the company's performance, and if your startup is acquired or goes public, you get to cash out.
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