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.
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It also takes much longer to receive money from an angel than from friends and family. The due diligence and legal processes required by angel investors can take several months. Angel investors only tend to invest once in a business, whereas friends and family can offer multiple rounds as they know the founder.
What is the difference between friends and family and angel investing? ›
Friends and family are persons who have a pre-existing connection to a company's founding team, but do not spend much time investing in private companies and have limited-to-no experience with such investments. Angel Investors are generally high-net-worth individuals who invest their own money in early-stage startups.
Should I invest in a Friends and family round? ›
Generally, the founders should not give up more than 10-15% of the company's equity in friends and family rounds. This is because the investors in a friends and family round are typically not professional investors and they may not be willing to take on a large amount of risk.
What is the difference between angel round and seed round? ›
The seed round usually happens when the company is at the initial idea stage, or once the founder has a prototype/proof of concept, as well as some kind of sign that there's a demand for what could be offered. An angel round often occurs when a company is only just launching, if not before.
Is an angel investor frequently a family member or close friend? ›
The angel investor may be involved in a series of projects on a purely professional basis or may be found among an entrepreneur's family and friends. The investor's involvement may be a one-time infusion of seed money or an ongoing injection of cash to get a product to market.
How does a friends and family round work? ›
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.
What is the average check size for an angel investor? ›
Typically, an angel investor will invest between $25,000 to $100,000 in each startup investment deal, though smaller and larger check sizes (like Thiel's) do occur.
What is the 70% rule investing? ›
Basically, the rule says real estate investors should pay no more than 70% of a property's after-repair value (ARV) minus the cost of the repairs necessary to renovate the home. The ARV of a property is the amount a home could sell for after flippers renovate it.
What is the 7 percent rule in investing? ›
The seven percent savings rule provides a simple yet powerful guideline—save seven percent of your gross income before any taxes or other deductions come out of your paycheck. Saving at this level can help you make continuous progress towards your financial goals through the inevitable ups and downs of life.
What are the most common problems with financing through friends and family? ›
Disadvantages of raising finance from friends or family
there is a risk your investors may offer more than they can afford to lose, or that they will demand their money back when it suits them but not your business. they may also want to get more involved in the business, which may not be appropriate.
Angel rounds typically range from $25,000 to $1 million, and the money is typically used to help the startup get off the ground. In exchange for their investment, angel investors usually get equity in the company.
What comes first, seed or angel investment? ›
Angel Round: Angel round funding comes after seed funding and serves as the next round of capital infusion to help startups scale their operations, refine their products, and gain market traction. 2. Stage of the Startup: Seed Funding: Seed funding is generally secured during the idea stage or early development phase.
What is the typical angel investor seed round? ›
Angel or “Seed” Round
There is a tremendous range in the amount of money raised at this stage. Investments can take the form of debt (typically convertible notes) or a priced round in which the founders are selling shares of stock in the company. Seed rounds can vary from $100K to several million dollars.
How big is a friends and family round? ›
How much do founders typically raise from a friends and family round? Investment amounts are low at this stage – typically between $10,000 and $100,000. Companies that ask for friends and family investment are usually valued under $1 million.
What is the average angel round valuation? ›
Benefits of angel investment valuation
The typical round size is between $250,000 and $1 million, with a $1 million to $3 million range for firm valuations.
How much equity is in an angel round? ›
The amount of equity that angels receive in return for their initial investment varies widely. It's typically between around 10% and 25% but it can be as much as 40% or more. Angel investment is most suitable if your business has growth potential, and you're willing to give up part ownership in return for investment.
Can an angel investor be a family member? ›
Angel investors can be friends, family, members of your professional or social networks, individuals or a team of investors. Angel investors often form “angel groups,” in which they evaluate businesses and invest together, pooling resources to make larger investments.
What are the three types of investors? ›
The three types of investors in a business are pre-investors, passive investors, and active investors.
What are angels in investing? ›
What Is an Angel Investor? Angel investors are wealthy private investors focused on financing small business ventures in exchange for equity. Unlike a venture capital firm that uses an investment fund, angels use their own net worth.
What defines an angel investor? ›
An angel investor is a wealthy person who invests his or her own money in a company—usually a start-up—that is in the early stages of development. Angel investors expect to take ownership positions in the companies they support because their capital is unsecured—they have no claim on the company's assets.
