Understand the differences between angel investment, VC, and PE in one article

If entrepreneurs try to obtain investment from investors (including individual and institutional investors) and gain recognition from the capital market during the entrepreneurial process, they first need to have a clear understanding of the capital market and various types of investors. Different types of investors have different investment priorities or tendencies. The main differences lie in the industry, enterprise, enterprise size or the development stage of the enterprise. If entrepreneurs can have a clear understanding of investors, it will be easier to identify “matching” investors when financing and improve the quality and efficiency of financing. This article conducts a comparative analysis of the three main types of investors in the current asset market: angel investment (AI), venture capital (VC), and private equity (PE) to help entrepreneurs judge the investment tendencies and preferences of different investors.

1. Conceptual distinction between three types of investors

(1) Angel investment (AI)

Angel Investment, referred to as AI, generally refers to the first investment received by a start-up company as an angel investment. As the name suggests, investors in angel rounds are like “angels”. They don’t seem to care about the success or failure of your business. They will give you money when your company doesn’t have a complete product and business plan, or even when it’s just an idea in your mind. Provide financial support. In addition to providing start-up capital to entrepreneurs, angel round investment has a greater significance in giving trust and support to entrepreneurs, encouraging them to take the first step and put their ideas into practice. 

The main characteristics of angel investment are as follows:

1. The amount invested by angel investors is relatively small, and the funds are often invested at one time. Their review of venture companies is not very strict. It is more based on the subjective judgment of investors or determined by personal likes and dislikes. Usually, angel investment is made by one person and the investment is taken when the investment is good.
2. Angel investors are the best financing targets for start-up companies. Because many angel investors are entrepreneurs themselves, they have a better understanding of the difficulties entrepreneurs face.
3. Angel investors are not necessarily millionaires or successful people with high incomes. Many angel investors may be your relatives, friends, business partners, suppliers, or anyone willing to invest in the company.
4. Angel investors can not only bring funds but also some human resources. If they are well-known people, they can also bring a certain reputation to the startup.

(2) Venture Capital (VC)

VC (Venture Capital), which is venture capital, also translated as venture capital, is mainly a financing method that provides financial support to start-up companies and obtains equity/shares of the company. The National Venture Capital Association defines venture capital as “a type of equity capital invested by professional financiers in emerging, rapidly developing enterprises with huge competitive potential.” Currently, the well-known venture capital institutions in the Chinese market are DCM Investment, China IDG Investment, Northern Light Venture Capital, Morningside Capital, Sequoia Capital, Capital Today, Matrix Partners China, etc.

VC has the following characteristics:

1. Most of the investment targets are small and medium-sized enterprises in the entrepreneurial stage, and most of them are high-tech enterprises.
2. The investment method of venture capital is generally equity investment, which usually accounts for about 30% of the equity of the invested enterprise. It does not require controlling rights, nor does it require any guarantee or mortgage.
3. Investment decisions are based on a highly specialized and procedural basis and generally require legal due diligence, financial due diligence, value assessment, model prediction, and other procedures.
4. Venture investors generally actively participate in the operation and management of invested enterprises and provide value-added services; venture investors generally also meet the financing needs of invested enterprises in various stages of development in the future.

(3) Private equity investment (PE)

PE (Private Equity), also known as private equity investment in Chinese, refers to equity investment in private enterprises, that is, unlisted enterprises, through private equity. During the transaction implementation process, future exit mechanisms are taken into consideration, that is, through listing, mergers, and acquisitions, Or making a profit from selling shares through management buybacks and other methods. The more famous PEs include Temasek, MBK, CITIC Capital, SoftBank, PAG, etc.

The three typical characteristics of PE are:

1. PE fundraising is private placement and extensive. PE investment funds are mainly raised from a few institutional investors or individuals through non-public means, and their sales and redemptions are conducted through private negotiations with investors.
2. The investment targets of PE are unlisted enterprises with development potential, and the criterion for selecting projects is that they will be able to bring high returns on investment through listing.
3. Integrate equity capital and management support. Since the purpose of PE investment is to obtain excess investment returns through listing, PE investment will not only bring investment to the company but also provide management support to the management.

The difference between the second and third types of investments

(1) Differences in target companies

1. Angel investment

Compared with VC and PE, angel investment should start to get involved in the enterprise at the earliest stage of development. Many times, angel investors have already invested funds before the company’s products and business have taken shape. Therefore, angel investors value the target company rather than the entrepreneurial team and the products of the entrepreneurial team. With the founder’s charm, such as personal aura, clear expression, eye-catching work experience, prestigious school background, etc., another important consideration is the founder’s understanding of the industry: The first is the understanding of industry needs: What are the industry pain points? How to position the product? Where is the product differentiation? Whether the founder and team can quickly produce products that meet or even exceed user expectations determines the success or failure of the startup. Secondly, the founder’s understanding of the industry is reflected in his understanding of industry development trends. In case the sector performs well, the founder will excel too; however, if the return on investment takes an extended period to materialize, investors may become hesitant or opt-out altogether.

2. VC

The projects invested by VC may be small and medium-sized high-tech enterprises that have just started. The enterprise has begun to take shape, but the business model is not mature enough and is still far away from listing. Most of the investment projects in the Internet industry that we often see belong to VC, the main features of this type of project are as follows:

(1) The risk is higher. Since the main investment targets of venture capital are small and medium-sized high-tech enterprises that have just started, the scale of the enterprise is still relatively small and there are no assets or funds that can be used as collateral guarantees, thus resulting in a significant level of investment risk. If technology cannot withstand the test of the market and cannot be transformed into finished products, the company is at risk of bankruptcy.

(2) Higher income. If the invested start-up company develops and increases rapidly in the future, venture investors can obtain a return on investment hundreds or even thousands of times. WhatsApp earlier decided to cooperate with only one investor, Sequoia Capital. Sequoia Capital invested a total of US$60 million in the company and finally received a huge return of US$3 billion. The return on investment is 50 times.

(3) Equity liquidity is low. Because VC invested in the company when it just started, capital realization must wait until the business scale of the company matures. This realization process takes at least 3–5 years. During this period, the capital invested by the VC or the capital held by the VC Equity is illiquid.

3. PE

The investment targets of PE are mainly unlisted enterprises with development potential. Whether the enterprise can be listed shortly and whether the listing can bring high returns are important criteria for PE to choose investment. Compared with AI and VC, in addition to the same emphasis on the advantages of enterprises, PE investment is more inclined to late-stage mature enterprises. Take Alibaba as an example. SoftBank invested US$20 million in Alibaba in 2000, and then invested an additional US$100 million in 2003 (part of the equity was later purchased by Yahoo for US$360 million), and again in 2005. Invested US$180 million. In 2014, Alibaba was listed in the United States with a market value of US$230 billion. SoftBank held 32.4% of the shares, worth US$74.5 billion, equivalent to 267 times MoM (Multiple of Money Invested, equivalent to the investment return multiple). Currently, SoftBank still holds 25.1% of Alibaba’s shares. Alibaba’s market value as of June 16, 2020, was US$597 billion. So SoftBank’s Alibaba shares are worth approximately US$150 billion, plus those between 2014 and 2020. Approximately US$20-30 billion was cashed out, and this investment brought SoftBank 600+ times its MoM.

(2) Differences in investment periods

1. Angel investment

Because angel investors invest in companies at their earliest stages, they have the longest investment period. It usually takes 3–7 years from investment to divestment, so they are also called “patient capital.” After angel investment invests, it cannot obtain cash in the short term, there is no dividend, and there is no interest. Profits can only be obtained after the company succeeds. A truly long-term investment project may result in considerable profits, or it may lose everything due to operational failure. The failure rate of angel investments is also relatively high. If divided according to investment stages, angel investment is also called angel round investment.

2. VC

The seed rounds, Series A, Series B, and Series C we often refer to are VC venture capital investments. From a case-by-case perspective, VC investment periods vary, but are affected by the fundraising period of the fund itself and the circumstances of the project itself, and usually exit within 5–10 years:

(1) After the duration specified in the VC partnership agreement expires, profits need to be distributed to investors (i.e. LPs), so it was necessary to withdraw from the invested enterprises one after another. The term of VC is usually 7–10 years, and some include extensions of up to 15 years.

(2) If the invested project is successfully listed or acquired, the venture capital fund can withdraw after the lock-in period expires. Of course, some companies are very promising and will continue to be held for some time. On the other hand, if the company is running poorly, the VC will have no choice but to continue to hold it or even ask the LP for an extension.

3. PE

The term of private equity funds generally ranges from 5 to 8 years. The period setting of private equity funds is divided into an investment period, exit period, and extension period. For example: the term of a fund is 5+2 years, then 5 years is the investment period and 2 years is the exit period; the term of a fund is 3+1+1 years, then 3 years is the investment period and 1 year is the exit period. One year is the extension period. The extension period is mainly used to continue working on legacy projects that failed to exit the previous year. Depending on the nature of the fund, the investment industry, the investment project, and the conditions of the capital market at the time of exit, the maturity setting of the fund is also different.

(3) Value-added services provided to enterprises

In addition to providing funds for entrepreneurs, angel investment, VC, and PE may also provide enterprises with value-added services other than funds.

1. Angel investment

Angel investors can not only bring funds but also contact networks, experience, materials, venues, labor, etc. to entrepreneurs. If they are well-known people, it can also improve the company’s reputation and credibility.

Angel investment is often a participatory investment. After the investment, angel investors often actively participate in the strategic decision-making and strategic design of the invested company; provide consulting services to the invested company; help the invested company recruit management personnel; assist in public relations; design and launch channels organize corporate promotions, etc. However, different angel investors have different attitudes towards post-investment management. Some angel investors are actively involved in post-investment management, while other angel investors may not care much about the management of the business and will not be too involved in business management.

2. VC

Excellent VCs may help entrepreneurs in the following aspects: (1) Provide strategic direction for entrepreneurs. VCs may have a seat on the board of directors and participate in board meetings to discuss the company’s strategic development direction and contribute to the company’s strategic development. Provide advice on direction or some important decisions, and help the company solve some obstacles encountered in the development process based on professional investment capabilities. (2) Recruit outstanding talents for the company. (3) Promote transactions, cooperation, etc. (4) Provide financial and legal guidance.

3. PE

Generally speaking, the size of the investment and the proportion of shares determine the amount of energy PE needs to spend on post-investment management. The main purpose of PE is to maximize the value appreciation of the enterprise. Therefore, private equity investors not only invest equity capital when investing but also provide very critical value-added services, such as helping to build management teams and providing information. Support, legal advisor, and other consulting services. Many PE institutions have relatively professional and high-quality personnel, so they can also give a lot of professional opinions on the decision-making of invested companies.

(4) Differences in exit methods

Different venture capital investments are not the same in terms of exit strategies, and there are even large differences in exit strategies. The differences in exit strategies require completely different abilities and resources for investors.

1. IPO exit

After the companies invested by VC and PE achieve IPO, investment institutions can sell their shares in the secondary market after the lock-up period to realize cash withdrawal. Judging from the current situation, domestic and overseas IPOs are still one of the important exit channels for investment institutions. Although judging from the proportion of IPO exit cases to the total number of exits, the importance of IPO as an exit channel seems to be declining, from the perspective of book return rate, IPO’s status as the most ideal exit channel for investment institutions has not been shaken.

2. New Third Board listing, transfer, and exit

Another important exit method for VC and PE is through the New Third Board (National Equities Exchange and Quotations). After the companies they invest in are listed on the New Third Board, investment institutions can transfer the shares to other holders through market making, agreement transfer, etc. or, thereby completing the exit. Before 2014, the New Third Board had been in a state of obscurity, and exit cases through this channel were very rare. The New Third Board officially expanded its capacity in early 2014. Starting in August, the New Third Board officially began to implement the market-making transfer method, which made the New Third Board market transactions more active. Since the second half of 2014, the New OTC Market has become hotter, with the number of listings and transaction volume increasing by leaps and bounds. In addition, the two major advantages of the NEEQ’s stratification and its role as a potential high-quality target pool for mergers and acquisitions of listed companies also make VCs and PEs more willing to see their invested companies listed on the NEEQ.

3. M&A exit

The other is that after the invested company goes public, it exits through mergers and acquisitions. M&A exit is a common method for VC and PE. Since 2013, the number and value of M&A cases in the A-share market have increased year by year, promoting the rise of this channel of M&A exit.

4. Corporate buyback and exit

Whether it is PE investment or VC investment, most investment agreements will have a repurchase clause, but funds at different stages treat this clause very differently. PE institutions will take the repurchase clause seriously and implement it; VC institutions will rarely require execution.

Despite the terms of the agreement, the investment industry also abides by certain industry conventions. It is normal for a PE institution to ask the major shareholders of the invested company to buy back, but if an angel investment or VC institution asks the founder of the invested company to perform a buyback, it will be considered unbelievable. You might even be laughed at by your colleagues if you spread the word.

For early angels and VC institutions, the default rule is that they are willing to admit defeat. Even if the investment fails, as long as the entrepreneurial team does not commit corruption and misappropriate public funds, within the scope of the rules, everyone is willing to gamble and admit defeat; if VC institutions also force If entrepreneurs are required to repurchase, I am afraid that many entrepreneurs in this market will not dare to start a business. But for PE institutions, I don’t know whether they are continuing the strategy of foreign PE, or whether the investment is more like a creditor’s right. In reality, the repurchase clauses of PE funds are often heavily implemented. This difference has led to repurchase becoming an important exit method for PE institutions.

5. Exit through other equity transfer methods

Equity transfer refers to the transfer of the company’s equity held by investment institutions to other investors for cash out, such as private agreement transfer, public listing transfer in the regional equity trading center (i.e., the fourth board), etc. Equity transfer exit is a common exit method for angel investors and VCs. Those who choose to exit through equity transfer often do so because the invested company has no hope of IPO or the investor is not optimistic about the future development prospects of the invested company, so they will exit through equity transfer in advance before the company goes public. In addition, the average book return multiple for equity transfer exits is also much lower than listing and M&A exits.

6. Liquidation and exit

This may be the exit method that direct investment institutions least want to see, because taking this method means that the project has completely failed. Liquidation is just a final stop-loss measure. As long as you can get your investment back, you are lucky enough. Probably for this reason, there are very few exit cases through liquidation. Of course, if the investor sets a repurchase clause and requires the major shareholder or actual controller to assume the repurchase obligation, even if it is liquidated, the principal and the amount may be recovered from the major shareholder. Corresponding fixed income.

The similarities between the three types of investments

Although many distinctions have been made between the three types of investors in many aspects, many distinctions are only conceptual distinctions. In practice, there are no strict boundaries between the three. If the project is good enough and the industry development prospects are promising enough, angel investment, VC, and PE will also break down various barriers to differentiation and be willing to invest a large amount of capital to wait for the company to realize cash in the future. In addition, as an enterprise gradually matures, it will attract the participation of different investment institutions at different stages, so an enterprise may have angel investors, VC,s or PEs. For example: “Are You Hungry” since 2011? In 5 years from 2016 to 2016, it received 7 rounds of financing. In terms of the investment decision-making process, a few angel investors may not do due diligence on the invested companies. Most investment institutions tend to conduct due diligence on the companies to check the basic risks of the invested companies. Angel investors’ due diligence It may be relatively simple, while the investment of VC\PE institutions is more professional and comprehensive.

4. Summary

Generally speaking, angel investment is investing in a project that has just started, with a lot of uncertainty. It is mainly individual investors and the investment amount is small. In VC venture capital, after the corporate strategy is initially formed, resource investment is needed to accelerate growth. At this time, more institutions are involved, usually in the form of funds and in the tens of millions. PE private equity invests in companies in the mature stage. At this time, the companies have a certain scale and market position. However, to reach a higher level, some need to be listed and some need to undergo industrial integration. In addition, different investment institutions may have different preferences and passions for industries. Some like to invest on the Internet, some like the artificial intelligence industry, and some like the live broadcast industry. Investment is also a two-way “rush” process. If entrepreneurs can choose the right investment institution, they can well assist the future development of the company.