What Are the Different Types of Investors?
Throughout a company’s lifecycle, its leaders will likely have to pitch investors to raise enough capital to fund the venture. As the business scales, fundraising may need to occur several times and in increasingly larger monetary increments. Further, each capital raise could come from a different source.
Part of the trick is knowing who to target and when.
To help with that, we have compiled a guide covering the different types of investors you may need to solicit at some point in your own growth journey.
Most companies will consider debt funding early on in the business cycle. Often, these funds are necessary to get a small business up and running, especially when the owner lacks the personal capital to fund the operation.
Generally speaking, there are two types of debt funding:
- Loan – The most common type of fundraising. In this case, a business loan is secured against assets within the business, along with a commitment that the principal will be repaid with interest. Depending on the loan’s conditions, there may be a set repayment timeframe.
- Convertible debt – A hybrid of both debt and equity, the borrower acquires funds from investors under the conditions that the loan will either be paid back or converted into company shares (at a certain valuation).
Naturally, banks and credit unions are the primary sources of debt-based loans. Because these are major financial institutions, they will want proof that your business will be able to pay back the loan or that there is enough collateral to back it. And to convince them of this, you will need to present a pitch deck that includes your business plan and financial statements.
Although you may hesitate to go into debt, this type of investment can provide several tangible benefits, including:
- The lender has zero control over the business
- You do not have to relinquish any equity
- Interest payments may be tax-deductible
- You have a potential partner to draw more funds from down the line
When you think of the different types of investors in a company, equity financiers are likely what spring to mind. In this exchange, the business owner sells a portion of the company’s equity in return for the capital. Unless otherwise stipulated, there is no obligation to repay the money; however, however, your investors will expect a return on their investment ROI through growing the business and maximizing the value of its shares.
There are seven primary types of equity investors, covered in detail below.
Friends and Family
In a business’ primordial stage, friends, family, and business contacts should be the first group an entrepreneur approaches for investment. But, at this point, there is likely little proof that the business model will succeed. So, they must rely on their belief in your character and abilities.
In this case, they are most likely funding you, not the company.
As a result, the asked-for capital tends to be much smaller—often between a few thousand to a hundred thousand dollars. It may be enough to get the company off the ground, but not so much that it will keep it afloat for very long without the company succeeding.
If you have a unique idea and proof of concept, the next level up from friends and family are crowdfunding platforms like Kickstarter. These utilize groups of people pooling their resources together to support a project they believe in.
Currently, there are four types of crowdfunding:
- Donation – People freely donate to your project simply because they consider it a worthwhile cause.
- Debt – Also known as peer-to-peer (P2P) lending, money provided by backers must be repaid with interest.
- Reward – For the most common type of crowdfunding, investors receive something in return for their donation. Generally, their reward is (exclusive) access to the earliest prototype or version of the good or service.
- Equity – In some cases, crowdfunding sources allow startups to exchange a small percentage of equity in exchange for donations.
In some instances, crowdfunding is a good way to start raising capital and could impress venture capital (VC) and private equity (PE) firms through consumer support. However, it is not a replacement for actual sales and revenue figures, especially since it tends to ride a viral wave that may quickly lose momentum.
Regardless, even after raising money, you will still need to figure out how to properly meet the sudden demand shock that crowdfunding creates across sourcing, production, pricing, distribution, manufacturing, hiring, marketing, and so on.
“Angel investors” tend to be the next step up in early-round investing.
These wealthy individuals actively search for smaller companies to invest in using their own money in exchange for an equity stake. They target early-stage “seed” or “angel” funding, which means the business could be just an idea or barely getting started. And the deals tend to range from tens of thousands of dollars to a million.
According to finance author Brian O’Connell:
“Angel investors come in after the original funding is in place but typically before a company requires a more sizable investment from a venture capital company. Their investment is needed to grow a company at a critical (and usually early) stage of development, after the initial funding threatens to run out and before venture capital groups show interest in partnering with a promising business.”
For more substantial capital raises, a group of angel investors may group up so as to reduce the potential risk profile.
Finally, the largest percentage of equity investors are known as private market investors. These groups raise capital pools from limited partners to invest in privately-owned businesses. The funds are there, and they are actively looking for the best companies to invest in.
Private market investors’ goal is to increase the value of the business they invested in and then eventually sell the company or their stake in it for a profit. As such, these capital rounds tend to be in the millions to tens of millions of dollars range.
The Small Business Administration points out that this type of capital injection differs from traditional financing since it tends to focus on high-growth companies, equity over debt, higher risks for higher returns, and longer investment horizons.
The two most common forms of private market investors are:
- Venture capitalist (VC) – VCs focus on funding, incubating, and mentoring promising startups in the hopes that the company will either be acquired for more money down the road or go public.
- Private equity (PE) – PE firms tend to focus on later-stage businesses and typically attempt to control a majority stake of the company in exchange for their capital. Once they have gained the reins to the business, their goal is to either optimize operational efficiency in order to drive profitability or to strip the company of its parts and sell it off.
Whether you are interested in debt funding or equity financing, there are dozens of potential fundraising investors. But knowing who to target and when to reach out is only half the battle. Especially, for more substantial capital raises, you will need to be strategic to simply get in the door for a pitch—let alone convince savvy investors to risk their capital on your enterprise.
For that, having an experienced CFO could make all the difference. The right partner will help you plan a financing roadmap, target the right investors, leverage their network, and then help you close a deal.
But you don’t need a full-time CFO to accomplish those goals. By partnering with one of CFO Hub’s outsourced CFOs, you could enjoy all of the benefits of having a fundraising expert without the costs of hiring someone full time.