Angels vs. Venture Capitalists: How Do They Think?

Before you make your first pitch, it's critical you know the mindset of these two groups.

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By Lisa Serwin

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You have a brilliant idea or have started a company. You know you need "OPM" (other people's money) and you think you are ready to pitch your deal. Are you sure? Do you know the angel and VC mentality? Before you make your first pitch, it's critical you know how these groups think.

How angels think

Angels are often your initial brush with outside investors (beyond friends and family). They often invest in companies that are just starting out, may or may not have a measure of success, a working product or a commercial launch. These companies may have customer interest but not necessarily signed deals. And they're often pre-revenue.

Related: 5 Qualities Angel Investors Want in Founders

Because angels typically invest in a company earlier than VC's, they take more risk and expect higher returns. Angels have an internal rate of return (IRR) they strive for on their portfolio of companies. (Think of an IRR as the rate of growth a project is expected to generate.) They typically prefer deals with an IRR in the neighborhood of 25 to 30 percent, depending on their particular philosophy.

The reason angels look for such a high IRR is that while every investor hopes every deal is a home run, the reality is that for angels out of every 20 deals they invest in, they typically anticipate 15 going bust, three to return some capital and one (5 percent) to provide a decent return. If 1 in 20 deals turns out to be a home run, angels are ecstatic -- and any angel who does better than 1 in 20 is considered a rock star.

How venture capitalists think

VCs generally join deals after angels. As a generalization, VCs invest in companies that have already experienced some modicum of success: a working prototype and/or a commercial launch, initial customers, contracts in the pipeline and some revenue. As a result, they characteristically experience better success than angels: typically five in 10 deals go bust, two return capital and one in 10 (10 percent) are home runs.

Related: 7 Essential Tips for an Effective Fundraising Strategy

VCs also anticipate a lower IRR than angels do -- usually falling in the 15 to 20 percent range.

Although the criteria differ from deal to deal, both angels and VCs look for capital efficiency, time to exit, coachable entrepreneurs, a large underserved market and protectable intellectual property.

It is worth noting that there is a third early-stage financing option: convertible or bridge debt. Now, entrepreneurs typically shy away from accumulating debt. However, a loan note can be less expensive to set up, easier to understand and faster to execute. (One cautionary tip: angels usually don't love it when there are convertible notes in a deal.)

How entrepreneurs should think

As soon as you know you need money and have a sound business plan and/or product, you should start meeting with angel groups. Many offer coaching and feedback; they can help you hone your business model, presentation and ask. Working with knowledgeable investors can help you develop meaningful milestones, determine which is the best entity type for your company (e.g., C Corp or LLC, among others), how many board seats make sense, how to balance the board (company, preferred, independent) and how to set up and think about option pools (15 percent is the average for the first round; with 5 percent "extra" for future rounds).

The key to working with any of these groups is that the earlier the money comes into your company the higher the risk for the investor and the higher the expected return. Be open, flexible, plan to learn and get the money and help you need to make your business a success.

Related: 4 Steps to Beating the Odds and Winning Startup Capital

Lisa Serwin

CEO and a member of the Life Science Angels

Lisa Serwin is the former CEO of AppMedicine.

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