Different Types of Investors
We all know that investors are a very important part of the entire start-up ecosystem. However, up until now, we have been considering investors to be one homogenous unit. However, that is not the case.
There are many types of investors who invest in start-up companies.
From an entrepreneur’s point of view, it is important to understand the type of investor with which they are dealing with. This is because different types of investors have very different motivations.
If the entrepreneurs understand the different motivations, then they can easily convince these investors to invest more.
In this article, we will have a closer look at the various types of investors as well as the different motivations that they have when they invest in start-ups.
- Venture Capital Funds: The most obvious type of investors who invest in start-up companies are venture capital funds. It is important to understand that venture capital funds do not have any money of their own. These funds raise money from investors who pool resources in order to benefit from the expertise of the fund managers.
It is important to realize that venture capital funds get a percentage of the income earned as a result of their investments. Also, they are widely experienced in investing in start-ups.
It is likely that the venture capital fund manager will try to offer a lower valuation since this will allow them to generate a higher return for their investor and therefore a higher commission for themselves.
It is important to realize that venture capitalists have a time limitation. Hence, if their fund is about to mature in a couple of years, they may rush the company to liquidate or generate cash flow in some way so that the fund can pay its investors back on time.
- Hedge Funds: Hedge funds are relatively new to the start-up financing stage. However, recently they have started investing large sums of money in this space. Since hedge funds do not specialize in making start-up investments, they prefer to invest in late-stage companies which carry a much lower risk.
Hence, in the early stages, companies should not waste their time trying to get funding from hedge funds. However, in the later stages, hedge funds can offer significantly higher valuations as compared to other types of investors.
- Angel Investors: Angel investors are a class of wealthy individuals who prefer to invest in start-up companies. These angel investors are often people who have made their own money by building a successful start-up. Hence, they may be very experienced in the workings of the company.
The important point to note is that angel investors use their own money. Hence, they do not have a deadline to return the money to any investors. They can therefore stay invested for a longer duration if they believe that the business is likely to do well in the near future.
There are many angel investors who invest for financial gain. However, a lot of the time, angels are passionate about building a business. This could also mean that these investors often tend to interfere with the day-to-day working of the firm. Sometimes the founder may appreciate such suggestions. However, at other times, this can lead to conflicts. Angels invest in the entire spectrum of start-ups right from the pre-seed funding stage to the late-stage companies.
- Corporations: There are many corporations that have a specialized arm that funds start-up companies. It is important to realize that corporations are not really in the business of making financial investments. The motive behind their investment tends to be different as compared to that of regular investors.
Corporate investors will often invest some money in a very early-stage start-up of a futuristic technology related to their business. They think of this investment as an insurance policy. Till the time, the investment becomes successful, the corporation will not interfere in the day-to-day activities. However, if the start-up does become successful, the corporation will try to acquire the company at a lower valuation.
Also, if they do not want to acquire the company, they will want to make sure that their direct competitors do not acquire futuristic technology. Hence, if a start-up takes investment from a corporation, it must know that future exit options may be restricted because of this funding round.
- Government: Governments in many parts of the world are important players when it comes to start-up funding. In many countries, governments have earmarked a fund that is allocated to start-ups. The idea is that entrepreneurship and job creation must be encouraged.
Needless to say, government funds are not allocated through investor pitches. Instead, they are allocated through a bureaucratic process. Sometimes this may work in the favor of the entrepreneur, since they may be able to raise funding on better terms.
Some countries have also created sovereign wealth funds which may also invest in start-ups. However, sovereign wealth funds behave more like mutual funds and less like the government. It is important for entrepreneurs to distinguish between the two types.
- Universities: There are many universities that have a substantial endowment that can be used to fund a start-up. However, universities do not generally invest to make exorbitant profits.
Often, these universities are trying to fund an invention that has been created by their students or professors. It is quite difficult for a company that is not in the university incubator to receive any funding from universities.
The bottom line is that even though every investor is trying to generate a profit, their priorities can be very different from each other. It is important for the founder to be aware of their motives so that the investment pitch can be modified accordingly.
Authorship/Referencing - About the Author(s)
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