The 9 Types of Startup Investors
Many first-time founders think that all investors have the same simple motivation: to make money. But veteran founders understand that there are different types of investors, each with their own motivations.
Believe it or not, there are at least 9 distinct types of startup investors:
Friends and Family
Angel Investors
Angel Groups
Family Offices (FOs)
Corporate VCs (CVCs)
Government VCs
Regional VCs
Power Law VCs
Multi-Stage Power Law VCs
Understanding the type of investor you’re pitching and their underlying motivations can help you to be more successful when fundraising and more discerning when choosing who to invite onto your cap table.
1. Friends and Family
Friends and Family investors are individual investors who knew you before you founded your company. Broadly speaking, they will invest in your startup because they believe in and are supporting you as an individual.
Despite the name “friends and family,” this investor category extends well beyond family members and personal friends. For most founders, the bulk of “friends and family” money comes from their professional networks, including former bosses, coworkers and others from their prior career.
When we raised DataHero’s initial round of funding, 4/6 individual investors were people that I had previously worked with at Aster Data.
In general, friends and family investors perform relatively little diligence, as their investment decision is driven primarily by their prior relationship with you. They also tend to have a lower expectation of financial returns relative to other categories of investors.
2. Angel Investors
Angel Investors are individual investors who did not know you before you founded your company. They will invest in your startup because they believe in your idea and the potential for you and your cofounders to execute on the promise of that idea.
There are two major subcategories of angel investors, with different motivations and objectives:
Professional Angels
Professional angel investors are angel investors for whom investing is their primary means of generating income. While they likely have a reasonable amount of wealth already (since they need capital to invest), they generally take a serious/formal approach to the process of angel investing, often including extensive diligence. At times, their approach to diligence can be frustrating to founders (“Investor X is trying to do Series A diligence for a $25K check!”), but it stems from the fact that they are trying to generate predictable returns from their activity.
Operator Angels
Operator angels, on the other hand, are angel investors with a full-time job who are investing either to supplement their income or to simply “pay it forward” to their local startup ecosystem. Many of these individuals come from a startup background themselves and have had an exit or two in the past. In general, operator angels will do significantly less diligence than professional angels and will often commit to an investment after a single meeting.
In established tech hubs like Silicon Valley, the primary motivation for many operator angels has nothing to do with financial returns. For some, it’s driven by the social capital they obtain by virtue of being an active angel investor (you can think of this as being akin to the prestige people get in other circles for making contributions to charities, athletic groups or the arts). For others, the motivation comes from wanting to establish an investing track record as a first step into a future career in venture capital. For many, it’s simply a matter of wanting to “give back” and help the next generation of entrepreneurs.
DataHero’s Pre-Seed round included two angel investors: one professional angel (Jerry Neumann) and one operator angel (Mike Greenfield).
3. Angel Groups
Angel Groups (also known as angel syndicates) are organizations that bring a group of individual investors together in order to streamline investment decisions. The basic concept is that the group can perform a single round of diligence on a startup, which the individual investors can then leverage to decide whether or not to invest.
There are a variety of angel group models when it comes to investing. At one end of the spectrum, some angel groups see themselves primarily as facilitators, bringing together startups and investors for group pitches while leaving the diligence and decision making to the individual investors. On the other end, some groups not only manage the diligence, but issue term sheets and facilitate the investment as a syndicate.
Angel groups are often filled with “operators” (people for whom angel investing is not a full-time activity), however, those individuals tend to not come from a startup background themselves. For them, a strong motivation for joining angel groups is to learn angel investing while “outsourcing” the core diligence to the group. As a result, angel groups tend to have more significant diligence compared to individual angel investors.
Angel groups/syndicates are not the same as AngelList Syndicates, which are a particular mechanism for aggregating small checks from multiple individual investors into a single line item on the cap table.
As with many things in life, there is a wide spectrum of quality amongst angel groups and it is critical for founders to understand who they’re dealing with.
“Good” Angel Groups
In the best cases, angel groups fill an important role in local ecosystems by bringing together large numbers of founders and individual investors. They provide first-time founders, in particular, with a platform to speak to many investors at once. In smaller ecosystems, pitching angel groups can be crucial for securing a first round of funding.
In addition, many angel groups provide education and training to new investors, helping to increase the amount of capital and number of angel investors in their ecosystem.
Casey Lau (Web Summit) and I recently led an educational session on Web3 for angel investors from across Western Canada at an event hosted by Angel Forum
“Bad” Angel Groups
Unfortunately, some angel groups have developed practices that are extremely unfriendly – and in some cases, predatory – towards founders. They take advantage of naive, first-time founders, demanding unreasonable investment terms that ensure the investors make money but can often doom the company from the start.
Beware a wolf in “angel’s” clothing
Some of the most egregiously unethical term sheets I’ve ever seen have come from angel groups, with liquidation preferences, clawback provisions and control terms that would be unheard of from other investors. These groups typically gaslight founder concerns and justify their predatory practices using some variation of “we’re taking the most risk, so…”
The most exploitive angel groups charge founders for the “privilege” of pitching to them or insist on fees to “cover the preparation of diligence materials.”
📣 You should never, ever, ever pay anyone to pitch them. 📣
As a founder, the best thing you can do when it comes to angel groups is to source references and feedback from other founders who have pitched them. What was the process like? How were they treated? And, most importantly, did it lead to an investment?
(The second-best thing you can do is to read Venture Deals by Brad Feld and Jason Mendelson, which is the single best resource on the planet for understanding investment terms.)
4. Family Offices
Family Offices are small organizations that manage the investment activities of particularly wealthy families and individuals. A typical family office will employ one or more investment professionals to evaluate and make investments on behalf of the family.
A perfectly normal family of billionaires
In some cases, the family members get personally involved in investment decisions (in which case, the experience is similar to interacting with an angel investor). In others, the investment team performs all of the diligence and manages the investment. Family offices generally have limited experience investing in tech (as startup investing typically represents a small fraction of family office investment activity). As a result, it’s common for family offices to have higher levels of diligence when evaluating startups and less favorable terms when they lead investments.
5. Corporate VCs (CVCs)
Corporate VCs are investing entities that are fully-funded by a single corporation.
There are many different structures of corporate VCs. For example, some CVCs invest from a dedicated pool of money and operate similar to standalone VCs, while others invest directly off of the parent company’s balance sheet. Some CVCs are structured such that investing partners have full discretion to make investing decisions, while others require champions from within the business to support a deal.
Within the landscape of corporate VCs, there are two main categories, based on their primary motivation:
Strategically-Motivated CVCs
Strategically-motivated CVCs, as the name suggests, are focused on making investments that support the strategic goals of the parent company (this is why they are often referred to as “strategic investors”). For these firms, the primary motivation isn’t to generate a financial return from their investment activity but, rather, to secure access to companies and technology that could provide a competitive advantage to the parent company.
The process of engaging with a strategically-motivated CVC can often feel closer to working with corp dev / business development than trying to fundraise from a VC. There is typically extensive diligence — particularly on the product side — with non-investing leadership from within the parent company often involved.
Raising money from a strategically-motivated CVC can potentially be advantageous from a sales perspective, however, there is an important drawback for founders to understand: raising money too early from a strategically-motivated corporate VC can potentially preclude any future investment from VCs.
Why? Because fundraising agreements include clauses that require major investors to agree to any acquisition.
When you raise money from investors who are financially-motivated, they will generally approve any acquisition that makes financial sense (regardless of who the acquirer is). Strategically-motivated CVCs, on the other hand, won’t approve all acquisitions, such as in cases where the acquirer is a competitor. As a result, taking investment from a strategically-motivated CVC can be seen by future investors as a signal that your value has been “capped” and will scare them away.
The vast majority of CVCs are strategically motivated. Depending on the stage and industry, the degree of signalling risk varies. The best investors understand the perception that taking their investment can have on a startup and will openly discuss the pros and cons — don’t be afraid to ask!
Financially-Motivated CVCs
Financially-motivated CVCs are corporate VCs whose primary motivation is to generate a return on investment. While they often leverage the parent company to their advantage (such as promising founders access to products and services offered by the corporate as a way of differentiating from other VCs), they are not focused specifically on identifying companies that can deliver a direct strategic advantage to the parent company.
There are only a handful of financially-motived CVCs. Prominent ones include GV (Google), Salesforce Ventures, M12 (Microsoft) and Decibel (Cisco).
Teradata confidentially invested in Aster Data as part of our Series C, as a precursor to acquiring the company 6 months later.
6. Government VCs
Government VCs are organizations that invest in startups on behalf of government entities. The most prominent of these operate at a federal level (such as BDC in Canada or SNIB in Scotland), but many provinces/states and even some larger cities have VC arms.
Similar to strategically-motivated CVCs, government VCs have motivations that go beyond financial return. Some of these include:
Economic development / job creation
Industry support (such as investing in domestic defense companies or certain industries that the government wants to encourage growth in)
Economic diversification
Supporting ESG/DEI efforts
The strategic motivations of government VCs generally don’t conflict with or restrict the activities of the startups they invest in, so there’s rarely a risk that downstream investors will be “scared off”. In fact, some government funds can provide a significant boost to a company’s reputation.
There is a wide range of sophistication and experience when it comes to government VCs. The best are run by career investors who operate similar to traditional VCs. Some have easy-to-qualify investing criteria, such as matching programs that can significantly increase the size of a round led by a recognized VC firm with minimal additional effort on the part of the startup. On the other hand, many government VCs — particularly in smaller ecosystems — are operated by teams with relatively little professional investing experience. Such organizations often have overly laborious diligence processes and can also have investment terms that are less favorable for founders.
For early-stage startups, the best way to leverage government VCs tends to be as follow-on investors, with primary diligence and terms led by a financially-motivated investor.
7. Regional VCs
The first of three categories of financially-driven VCs (also known as “traditional VCs” or “institutional VCs”) are Regional VCs. These are venture capital firms for whom the majority of their deal flow comes from a relatively small region.
Regional VCs differ from power law VCs in that their investment strategy assumes that it is unlikely that they will invest in a billion-dollar company within any given fund. In the ecosystem where they invest, unicorns aren’t created with enough frequency or predictability to allow VCs to factor them into their fund model. As a result, they must construct an investment strategy that will generate a return for their investors without a single unicorn in their portfolio.
The most obvious distinction that founders will experience between regional VCs and power law VCs is that the former tends to do more extensive diligence on revenue, sales cycles and short-to-medium term business plans. Regional VCs tend not to focus much on high growth scenarios because they’re discounting the likelihood that it will occur. Instead, their diligence focuses on what they believe to be the more realistic/likely scenarios for the company (typically based on historical performance of companies from within the region). Interacting with regional VCs can sometimes be extremely frustrating for founders, particularly given that the experience can seem at odds with what they read about VCs and fundraising online.
The vast majority of regional VCs are extremely supportive, particularly when it comes to helping promising startups expand beyond their region. However, in small/emerging ecosystems — particularly ones with only one or two VCs — founders should be wary of the terms offered by regional VCs. Similar to “bad” angel groups, there are, unfortunately, “bad” regional VCs who are known to push terms that are extremely unfriendly to founders and would be out-of-market in larger ecosystems.
As with angel groups, the best thing you can do when it comes to regional VCs is to source references from other founders who have worked with them. In particular, find out how they behaved after the investment was made and whether they added or extracted value.
8. Power Law VCs
Power Law VCs are VCs whose investment thesis is strictly based on an assumption that returns in venture follow a power law distribution. These investors expect one or two companies to drive the returns of their fund, while the rest will provide a rounding error.
The majority of VCs in Silicon Valley are power law VCs, whereas the majority of investors in other ecosystems around the world are regional VCs.
Panache Ventures is one of only a handful of power law VCs in Canada. We invest exclusively in companies that we believe could reach a valuation in excess of $1B within 7 - 10 years.
In general, the diligence performed by power law VCs focuses on growth and growth potential. They dig deep into early traction in order to understand how “real” it is, while worrying less about short-term finances and profitability. Their goal is to figure out how big your company can be and how fast you can get there, in order to determine whether or not you are a fit for their investment thesis.
Power law VCs primarily operate in larger ecosystems that are highly-competitive amongst investors. As a result, they tend to offer “cleaner” term sheets with predominantly founder-friendly terms (since issuing non-market terms could cost them the deal in a competitive scenario).
It is important to understand that if you raise capital from a power law VC, you are committing to an objective of building a $1B+ company within 7 - 10 years. For many founders, that is not actually their goal (and that’s okay!). It’s important that you be clear about what type of company you want to build before accepting capital from a power law VC.
9. Multi-Stage Power Law VCs
Multi-Stage Power Law VCs, as the name suggests, are power law VCs who invest in companies at multiple stages (such as Seed, Series A and Series B). The largest and most prominent VC funds in the world are all multi-stage firms, including Sequoia, a16z and Tiger Global.
Aside from the obvious fact that multi-stage VCs have more money and resources than smaller VCs (so can write bigger checks and offer more services to founders), the main difference comes from the fact that they can lead multiple subsequent rounds in a company. It’s not uncommon for a multi-stage power law VC to lead 2 or even 3 rounds in a company they believe will be a winner within their portfolio.
One risk for founders to be aware of is multi-stage VCs investing “earlier” than they typically do.
For example, if Big Prominent VC™ is known to invest in Series A and Series B rounds, but offers to invest in (or lead) your Seed round, that can seem exciting (and in many cases, it is!). But it can also be the case that they’re simply investing a nominal amount of money (to them) so they can get an early look at your next round. This can post a risk to your ability to raise the next round, if Big Prominent VC™ declines to invest (leading other investors to presume that they saw something they didn’t like).
Another risk with taking investment “too early” from a multi-stage VC is that they might not actually be able to add value yet — or worse, could be counterproductive. Many larger funds are used to investing only after startups have product-market fit. If you’re a true Seed stage company that’s still trying to figure it out, you might benefit more from “stage-appropriate” investors who focus exclusively on helping startups attain it.
When diligencing multi-stage power law VCs, be sure to get references from companies that were your exact size and stage when the firm first invested in them.
There are many different types of investors, each with their own motivations, strengths and potential risks. The vast majority of investors genuinely want to support and help startups, but it’s essential that you do your research and always seek out founder references.
