Angel Investors, Venture Capital and Mezzanine Financing
Whether you are a startup looking to take your idea to its physical form or a business looking to take on the next level of growth, raising capital is one of the first steps you need to think about. Funding is literally the fuel to keep the engines running and it acts as a catalyst for accelerated growth. But it’s not easy to make decisions regarding the financing of your company.
There are many options available and each has a role of its own. To make the right decision, it is important to know the differences between all the options and to select the one that fits your needs the best. Traditionally, entrepreneurs would go to a bank to secure a loan to fund their company. They would pledge the company’s assets as well
as their own personal assets (if needed) as collateral and would pay interest on the loan they received.
Today, however, with a changing world, the needs of the entrepreneurs and their companies, as well as the methods of financing have evolved. It is these avenues that are more prevalent today. Entrepreneurs usually go for angel investors, venture capital or mezzanine financing. Each investor has their own merits and demerits and the
decision to choose any one of them depends on your requirements. Therefore it is vital to understand what each entails.
Angel Investors
Angel investors are usually high net worth individuals or a group of such individuals who use their own money to fund startups or entrepreneurs, in contrast to professionally managed funds. They typically require a share of ownership equity in the business that they are financing. It is common for an entrepreneur to find angel investors among their
family and friends but it might not always be the case. Many wealthy individuals are on a constant lookout for potential hits and so founders can approach them and pitch their ideas. There are dedicated websites, like AngelList,
that make it easier for founders to reach out to angel investors. This particular investment avenue has been portrayed well on the popular TV show, Shark Tank, where founders can be seen pitching to angel investors, known as sharks on the show. The main advantages of choosing angel investors are that they might be easier to find and approach, especially if they are in your circle. Also, they are usually business
leaders and ex-entrepreneurs themselves, so along with their funding, they also bring in their expertise and experience. Also, their funding is directly proportional to the equit you are willing to exchange and so, you can still keep control of your own company. There are some disadvantages too, however. If some of your family members or friends turn out to be your angel investors, it could be difficult to handle their money due to the personal relations and it might even put a strain on the relationship. Also, if you require a lot of capital, this is not usually the right path.
Venture Capital
Venture capital falls into the realm of professionally managed funds. They typically invest in new ventures using funds raised from a limited number of sources such as pension funds and endowments. These funds are managed by professional investors known as venture capitalists. Also, they are usually on the lookout for companies that
have long-term growth potential, which could multiply their investments by orders of magnitude. Therefore, venture capital is the more professional method of seeking investment. This route should be chosen if the funding requirement is quite high, generally more than a million dollars. This also means that venture capitalists will own a larger share of your company’s equity and could also require control rights by way of having seats on your
startup’s board. The biggest advantage of choosing a venture capital is that they can potentially offer a larger amount of funding. This could skyrocket the growth rate of any startup if managed properly. They also have very powerful connections and their networks are priceless. They could leverage this to make sure that your startup gets all the help it requires to succeed. Since they have skin in the game, which is rather large, it is in their best
interest to help you. The downside is that since they provide large funding, they can acquire an inordinate
amount of control in your firm. In the worst-case scenario, this means that they could even replace you as the CEO of your own company if they think that you are not the right person for the job.
Mezzanine Financing
Mezzanine financing is a hybrid of debt and equity finance, where the lending party has the right to acquire an ownership or equity interest in the company if their loan is not paid back on time or in full. This kind of financing is usually provided to companies that are already well established rather than startups or companies that are looking for seed funding. Investors usually look for cash flow positive companies that can be expanded further. This can include adding product lines, making acquisitions or pursuing other growth opportunities. In a company’s capital structure, mezzanine financing exists between senior debt (such as banks and venture capital companies) and common equity. There are many benefits to acquiring mezzanine financing. The lenders are usually long-term investors in the business and such funding requires little to no collateral on the part of the borrower.
Also, being backed by mezzanine financing increases the odds of obtaining other types of financing from traditional creditors. The other great thing is that this type of financing doesn’t typically require payment during the term of the debt, only at the end of the term. This allows the business to use it for growth and generating more profits. One
drawback here is that mezzanine financing usually commands a significantly higher rate of interest, which could be in the range of 20%-30%.