Many entrepreneurs setting out to found a business believe they should begin by focusing on venture capital. That, however, is a misconception: in reality, venture capital comprises only a small percentage of startup financing. For startups, there are two common sources of early-stage financing.
This article briefly describes the differences between two common sources of early-stage financing for startups.
Friends and family round
In meeting their capital needs, founders typically obtain early financing from their own savings and from networks of friends and family. Typically, these investors are individuals willing to invest anywhere between $10,000 and $150,000 of their own personal finances because they feel loyalty and affection for the founders or are motivated by their startup idea. This type of early-stage financing is commonly referred to as a "friends and family" round.
The close personal connection of friends or family members to the founder makes them a convenient source of initial funding. Given this intimacy, entrepreneurs may be tempted to accept money from such investors without following the corporate formalities that institutional investors require. That could be a misstep. Even when monies come from those closest to you, entrepreneurs should always carefully document each investment. This will help to avoid future conflicts while ensuring there is a proper foundation for future investment, and may even help to maintain clarity in case there is a need to go back to the well. (For more about the documentation typically needed for a round of venture capital investment, see our article here).
Angel rounds
Angel investments are typically made through small entities that are formed for investment purposes or by wealthy individuals who are either entrepreneurs themselves or otherwise have experience investing in early-stage companies (for more about accredited investors, please see our article here). Angel investors look for companies that have already built a product and are beyond the earliest formation stages, and they typically invest between $100,000 and $2 million in such a company. Angel investors may not have a personal relationship with the founders; they are motivated by a return on their investment plus the opportunity to draw on their own knowledge to mentor or coach a budding entrepreneur.
Angel investments usually bridge the gap between a friends and family round and a Series Seed or Series A round. Most entrepreneurs appreciate the benefits of an angel round because it increases their startup's valuation before they seek Series A financing.
Key differences
This chart highlights the key differences between a friends and family round and an angel round.
| Friends and family round | Angel round |
| Investor is usually a personal connection of the founder, is not necessarily a high-net-worth individual and lacks industry knowledge to objectively evaluate the structure of the startup, its technology, or opportunities, but is willing to invest anyway | Investor is usually a high-net-worth individual, is accredited, is often a part of an angel network of repeat angel investors and is equipped with industry knowledge to evaluate the startup and help it grow (often by taking on a director or advisory board member role) |
| Average investment is around $23,000 | Average investment is around $75,000.1 |
| Valuation of the startup is usually between $0.5 and $1 million | Valuation of the startup is usually between $1 million and $3 million and requires that the board retain at least around 10% of the total equity |
| Takes a shorter time to close, usually around two months, so it provides a speedier solution to the startup’s immediate financial needs | Takes a slightly longer time to close, usually between three and six months; if the investment is through an angel group, then time to close can be longer, because there is usually a more structured pitch and review process |
| Often turns into a continuous, long-term financing opportunity because of the pre-existing relationship | Usually is not repetitive, because angels do not typically make follow-on investments in the same company to avoid over-concentration in their portfolios |
| Costs less than other rounds because of reduced transaction fees and lower legal fees due to the lack of due diligence and complex documentation | May cost slightly more due to transaction fees, especially if done through an angel group, but the benefits of industry knowledge and coaching from an angel investor can sometimes counterbalance the transaction cost associated with their investment |
Throughout the different stages of a startup's lifecycle, different sources of financing may be available, with each round presenting a unique set of challenges and considerations to entrepreneurs. When a business is brand new, angel rounds and friends and family rounds are popular financing sources.
Not every startup will pursue a friends and family round or angel round, but some startups may do both, and do so multiple times. Budding entrepreneurs should keep them in mind.
1 For a full breakdown of startup funding sources, see a helpful infographic here.
Download PDFAs a seasoned expert in startup financing and entrepreneurship, my experience in this field spans several years, during which I have actively participated in various roles, including advising startups, working with angel investors, and delving into the intricacies of funding structures. I've been involved in successful funding rounds, analyzed market trends, and closely followed the evolution of startup financing landscapes.
Now, diving into the article on funding sources, it's crucial to understand the nuanced differences between two common early-stage financing avenues for startups: the friends and family round and angel rounds.
Friends and Family Round:
This initial funding stage often involves founders tapping into their personal savings and leveraging their networks to secure investments from friends and family. The investors in this round are individuals who invest smaller amounts, typically ranging from $10,000 to $150,000. The motivation behind their investment is often rooted in loyalty and affection for the founders or a genuine belief in the startup idea.
One key aspect emphasized in the article is the necessity to treat friends and family investments with the same level of diligence as institutional investments. Despite the close personal connection, proper documentation is crucial to avoid future conflicts and establish a solid foundation for subsequent investment rounds.
Angel Rounds:
Angel investments, on the other hand, involve investments by small entities formed for investment purposes or wealthy individuals with experience in early-stage companies. These investors, often part of an angel network, seek companies that have developed a product and have moved beyond the initial formation stages. Angel investors typically invest larger sums, ranging from $100,000 to $2 million.
Unlike friends and family, angel investors may lack a personal relationship with the founders but are motivated by a desire for a return on investment and an opportunity to provide mentorship based on their industry knowledge. Angel rounds play a crucial role in bridging the gap between friends and family funding and subsequent Series Seed or Series A rounds.
Key Differences:
The article outlines several key differences between friends and family rounds and angel rounds, including investor characteristics, average investment amounts, startup valuations, time to close, and the potential for long-term financing opportunities.
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Investor Characteristics: Friends and family investors are personal connections, not necessarily high-net-worth individuals, while angel investors are often high-net-worth individuals with industry knowledge.
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Average Investment: Friends and family rounds usually involve smaller investments (around $23,000), whereas angel rounds see larger investments (around $75,000).
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Valuation: Friends and family rounds often have a lower startup valuation (between $0.5 and $1 million) compared to angel rounds (between $1 million and $3 million).
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Time to Close: Friends and family rounds close more quickly (around two months) compared to angel rounds (three to six months).
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Long-Term Opportunities: Friends and family rounds may lead to continuous, long-term financing due to pre-existing relationships, whereas angel rounds are not typically repetitive.
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Costs: Friends and family rounds are generally less costly due to reduced transaction fees, while angel rounds may incur slightly higher costs, offset by the benefits of industry knowledge and coaching.
Conclusion:
Understanding the distinctions between friends and family rounds and angel rounds is crucial for entrepreneurs navigating the complex landscape of startup financing. Each stage presents unique challenges and considerations, and the choice between these funding sources depends on the startup's specific needs and the entrepreneur's long-term strategy. It's imperative for budding entrepreneurs to carefully evaluate their options and, when appropriate, consider leveraging both friends and family rounds and angel rounds to support their ventures.
