Understanding the Different Types of Investors: A Complete Guide

Starting a business can be both an exciting and daunting journey, often requiring significant financing to get the venture off the ground. In many cases, the capital required to launch your startup may exceed your personal capacity to invest. So to fill that gap, you’ll need to seek out external investors who believe in your vision and are willing to put their money where they seems interested

Different types of investors invest at different stages of company development, and have different risk profiles and expectations about their involvement in the company’s board and governance. Generally, investors receive equity—partial ownership in the company—in exchange for the money they put into the business. Investors may also receive various voting rights and preferences based on the terms of their investment.

What is an Investor?

An investor is an individual or entity that allocates capital with the expectation of a financial return. They are the fuel in the engine of business growth, providing the resources necessary for startups to scale, innovate, and penetrate markets. Investors come in various forms, each with a set of motivations, expectations, and contributions to a business’s journey.

Know the difference: Types of Investors

1. Friends and family

A "friends and family" round refers to the initial capital funding that a startup, particularly at a very early stage, receives from the personal network of its founders. Investors in this round usually bet on the founder's character and potential rather than the industry or vertical. However, before accepting funding from friends and family, it's essential to consider the personal costs and stress involved in taking financial investment from loved ones. Even successful startups typically have a minimum ROI period of 10 years, meaning that your family and friends may not see any returns for an extended period. Therefore, if the investment is too risky for them and could cause unnecessary stress, it may be better to decline.

It's worth noting that not all entrepreneurs can raise money from their friends and family, which contributes to the ongoing inequity in the startup ecosystem. Availability of this type of funding depends on the assets and liquidity within the entrepreneur's personal network. However, if a friends and family round is not feasible, it's crucial to remember that there are other funding options, and a startup can still succeed without raising funds from the founder's family. In fact, many successful startups did not raise funds from their founders' families.

2. Equity crowdfunding

Equity crowdfunding is the process of collecting small contributions from many people, typically through online crowdfunding platforms. Some crowdfunding websites specialize in fundraising for businesses and can get the pitch out to a large group of general investors (unaccredited investors included).

3. Angel investors

Individual investors known as angel investors have an annual earned income of over $200,000 or a net worth exceeding $1 million. They can be identified in various industry sectors, and they typically collaborate with entrepreneurs who are seeking financing for the first time or are in the process of securing venture capital.

4. Accelerators and incubators

Startups can receive guidance, mentorship, and funding access from accelerators and incubators in exchange for a company equity stake, with some also making direct cash investments. Accelerators focus on early-stage companies, including founders looking to develop minimum viable products (MVPs) and business plans into thriving businesses. These programs, which require startup applications, usually last a few months and culminate in a demo day where startups showcase their ideas to peers and potential investors. Examples of accelerators include Y Combinator and TechStars.

Generally speaking, incubators assist startups for a more prolonged period than accelerators, which usually last a few intense months. Incubators serve as a base for founders to establish their businesses, which can take up to a year or even more. In contrast, accelerators typically require applicants to have a minimum viable product (MVP), while incubators often engage with startups at an earlier stage, such as when the business is merely an idea or a hopeful founder is still exploring potential concepts.

Moreover, incubators usually offer a shared working space for their startup founders to utilize as an office during the initial phases of their company's inception. They also provide mentorship, networking opportunities, and sometimes even funding. Some incubators operate as nonprofit organizations in specific geographical locations, aiming to foster innovative businesses within their region.

Examples include Seedcamp, Capital Factory

5. Venture capitalists

A venture capital (VC) firm gathers funds from external sources to provide capital to privately owned companies, typically high-growth startups. The leaders of a VC firm are known as general partners (GP), who manage the funds provided by limited partners (LP), who contribute the majority of the capital. Unlike angel investors who invest their own money, GPs act as trustees of the LP's investments.

During a funding round involving VC firms, there is usually a lead investor who contributes the most significant amount, along with other investors who write smaller checks. The lead investor often plays a more active role in governance and oversight than the other investors. In priced rounds, lead investors may demand a board seat or special voting privileges. These terms are negotiable during the term sheet stage and are more common in VC firms than with angel investors, friends and family, or accelerators.

Different VC firms focus on various stages. Some invest during the early stages, such as seed or Series A, or even write pre-seed convertible notes, while others focus on later stages. In some cases, VCs who invest during the early stages also provide follow-on capital, funding subsequent rounds to enable the company to grow, without adding new external partners.

VC firms may establish multiple funds with distinct investment strategies. These funds may focus on specific themes, like climate, AI, or SaaS (software as a service). Therefore, it's crucial to understand a firm's stage and investment thesis before approaching them for funding.

Examples of venture capital firms include: Andreessen Horowitz, Sequoia Capital, and First Round Capital.

6. Growth equity

Private equity firms that specialize in growth equity focus on providing capital to more established startups that are closer to achieving an initial public offering (IPO) or another form of liquidity, such as a sale, within the next few years. Unlike early-stage venture capital (VC) investors, who typically look for high-growth potential and are willing to accept a higher level of risk, growth equity investors prioritize more mature metrics such as revenue growth and cash flow. As a result, they have a lower risk tolerance and, in exchange for their investment, typically receive a lower ownership percentage compared to earlier investors.

Examples of growth equity firms include: Summit Partners, General Atlantic, and TA Associates.

7. Institutional investors

Typically, institutional investors are large asset managers, such as Fidelity and T. Rowe Price, state pension funds, university endowments, banks, hedge funds, mutual funds, and family offices. These investors usually act as limited partners (LPs) in venture capital funds, which then invest their money in startups in various stages. Nevertheless, institutional investors may directly invest in startups, particularly in later-stage companies like growth and pre-IPO firms.

8. Corporate investors

Corporate venture capital (CVC), a type of investment that falls under the broader category of venture capital, involves partners from firms investing in startups on behalf of large corporations, typically in industries related to the corporation's core business. Unlike traditional venture capital investments, CVC investments are made using the corporation's own funds, instead of capital from limited partners.

Examples of corporate venture capital firms are Intel Capital and GV, the corporate venture arm of Alphabet, Google’s parent company.

Other ways to finance your startup without granting equity to investors:

1. Bootstrapping

Growing a company using one's own resources, without external financing, is known as bootstrapping. Personal savings, credit cards, low-cost or free tools and services, and reinvesting initial profits are all examples of bootstrapping resources. This method is essential for many early-stage startups, as they have not yet demonstrated enough potential to secure outside funding.

Bootstrapping may involve working on a startup idea outside of regular work hours or with minimal resources for some founders. This could mean using personal savings to fund the company, which is not a viable option for every entrepreneur.

Reinvesting early profits is another way companies may choose to bootstrap. However, the feasibility of this approach depends on the type of business. A direct-to-consumer retail company that can start generating revenue early on is more likely to take this approach than, for instance, a healthcare startup that may need to undergo years of clinical trials before hitting the market.

2. Bank loans and debt financing

Just as with other small enterprises, startups have the option to apply for business loans to facilitate their growth. In contrast to giving up a share of your company's ownership and diminishing the ownership value of you, your co-founders, and other investors, obtaining a loan means you commit to repaying the borrowed amount to a financial institution along with an agreed-upon interest rate.

This method of obtaining funds through bonds and loans is commonly known as "debt financing," as opposed to equity financing Equity financing encompasses all the various investment types mentioned earlier.

3. Grants and Competitions

Grants and competitions provide startups with valuable revenue to secure non-dilutive funding, often in the form of cash prizes, resources, or mentorship. By diligently pursuing government and industry grants, developing compelling applications that showcase their startup’s potential, and actively networking within their industry to build relationships and gain insights, startups can increase their chances of securing grants or winning competitions, contributing to their growth and success.

4. Vendor Financing

Vendor financing, or trade credit, is a clever way for startups to stretch their cash by delaying payments to suppliers. By nurturing strong supplier relationships, negotiating extended payment terms, and strategically using business credit cards, startups can unlock valuable short-term funding to fuel growth and seize opportunities without diluting ownership or paying hefty interest rates.

5. Invoice Factoring

Factoring offers startups a quick way to convert unpaid invoices into cash by selling them to a third-party company at a discount. This improves cash flow and allows you to invest in growing your business. Platforms like MarketInvoice and BlueVine specialize in offering this financial service to startups.

Ending Note

It's important for startups to understand the different types of investors. I hope this blog helps you to explore non-equity funding options and different types of investors. Raising startup funding without diluting capital is achievable through a variety of strategies as we discussed. By carefully considering these options and leveraging available resources, startups can maintain ownership while acquiring the capital needed to fuel growth and achieve long-term success.

Every source of funding brings its own rules and possible hurdles. To pick the best choices for your company, you need to do careful planning.