How do Angel Investors operate, how are they different from VCs?

Investors looking to invest in venture companies, i.e., start-ups, can do this in two ways; becoming a part of a venture capital fund or taking individual calls on their investments.

In some way, this can be compared to how an investor chooses to invest in the listed equity space: either through a mutual fund or by taking individual calls on companies.

As of 2021, India had over 10000 angel investors and more than 800 Venture Capital firms. However, this number, especially angel investors, need to grow tenfold, to further fuel the startup ecosystem’s growth.

So what’s the difference between Angel investors and Venture Capital Funds?

What is a Venture Capital Fund?

1. A venture capital fund is a combined pool of investment capital collected from several investors, including individuals, family offices, corporates, and other funds.
2. Fund managers, also called General Partners (GPs), run the fund. They are responsible for making investment decisions on behalf of the investors who invest in the fund.
3. The Investors pay an annual management fee (up to 2%) to the fund managers for managing the investments through the fund’s life.
4. The investors also pay the fund managers a share in the profits, called carry in industry parlance, which kicks in once the investors’ capital and a minimum return is returned. Typically, the profit share is 20% for the fund managers after a typical minimum return of 5-10%, depending on the asset being invested in.

Who are individual investors, i.e. Angel Investors?

1. As compared to the above, Angel Investors are individuals, corporates or family offices deciding on investments deal by deal.
2. Angel investors increasingly invest in these deals via investment platforms like Mumbai Angels, which ensure they get to choose from a wide range of companies to invest in.
3. Mature investors use a portfolio approach to invest in venture companies like they do in all other asset classes. Our recommendation to all investors is to build a minimum portfolio of 30 companies, invest equal amounts across companies, and regularly invest across various sectors. The other important strategy is to double investments in companies that are doing well, build in failures of companies as an inherent risk of the asset class and stay invested till the next round investor insists on the investor taking an exit.

The pros and cons of the two strategies

 Decision making: This is the primary decision that an investor needs to make before choosing either of the options. If the investor is looking to take individual calls on each investment, deal-by-deal investing is a better option as the VC fund route is a blind pool where a collective decision is taken by the fund manager.

Time commitment: Direct deal-by-deal investment, like in all assets, will require the investor to invest considerable time and energy to understand the intricacies of venture funding. Investors cannot switch on and off depending on the time they have in hand. If the investor is pressed for time, for example, if they are running their own business or have a full-time demanding job, investing in a VC fund is a better route.

Networth: Indian laws require a minimum INR 1 crore investment in a VC Fund, whereas individuals can start investing with a minimum commitment of INR 25 Lakhs to be deployed over 5 years with investment platforms.

One point of caution: whether one chooses to invest directly or via a fund in venture companies, the risks associated with this asset class should be carefully considered. We recommend a maximum of 5% allocation to this asset class for any investor in their overall portfolio initially, till they get a deep understanding of the associated risks and returns. The investor also has to have a long-term perspective in mind, a minimum of 4-5 years, as this is a relatively illiquid asset that will only return the money once there is a buyer for the start-up.

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