When entrepreneurs decide that an opportunity is worth exploiting, they often lack the capital (i.e., money) needed to exploit the opportunity. Although some entrepreneurs fund their operations with their own money or with credit cards, most entrepreneurs require at least some external money to fund their operations. In this section, we review three primary sources of external capital for entrepreneurs: angel investors, venture capitalists, and bank financing.

Angel investors are wealthy individuals who provide capital to new companies.35 Angel investors may include an entrepreneur’s family and friends, but angel investors are also private individuals who did not know the entrepreneur prior to funding the opportunity. Angel investors have existed for centuries—in fact, in 1903, five angel investors helped Henry Ford launch his auto company with a total of $41,500. Within 15 years, those angels’ investments were worth a whopping $145 million!36 Today, approximately 140,000 angel investors provide about $9 billion in capital to nearly 25,000 new ventures each year.37

Venture capitalists are firms that raise money from investors and then use this money to make investments in new firms. Many prominent companies such as Intel and Microsoft received investments from venture capitalists in their early days. The companies then used these funds to help acquire the resources (i.e., employees, equipment, etc.) that eventually made them the companies they are today. Although the use of venture capital in the United States peaked at about $100 billion during the dot-com frenzy of 1998 to 2000, the venture capital industry today totals nearly $18 billion.38

It is important to note that both angel investors and venture capitalists provide money to entrepreneurs and in return receive a portion of the firm’s equity. In other words, in return for their investment (money) in the entrepreneur’s firm, the entrepreneur gives them partial ownership of the firm. As such, when the entrepreneur’s firm does well and increases in value, the investors’ investments also increase in value. Likewise, when the entrepreneur’s firm does poorly and decreases in value, the investors’ investments also decrease in value.

Although similar, angel investors and venture capitalists differ in a number of significant ways. In contrast to angel investors, venture capitalists make fewer investments, but those investments are often larger than the investments made by angel investors. In fact, the average investment of venture capitalists is approximately $4 million, whereas the average investment of angel investors is about $75,000.39 In addition, venture capitalists typically focus on a small number of industries, whereas angel investors tend not to focus on particular industries. Finally, venture capitalists typically invest in firms after they’ve passed the initial, start-up stage. In other words, angel investors typically provide the initial financing to start-up ventures, and venture capitalists provide additional capital as the new venture becomes established.

In sum, angel investors and venture capitalists are sources that entrepreneurs may use to fund new ventures. Whether an entrepreneur obtains funding from an angel investor or from a venture capital firm, however, it is important to note that such relationships present specific challenges and must be entered into with caution.40

Bank financing occurs when an entrepreneur obtains financing from a financial institution in the form of a loan. It is important to note that unlike angel investors or venture capitalists, banks are not investors. Instead, banks make loans to entrepreneurs and in return expect repayment of the loans with interest. As such, banks are not concerned with the long-term potential for returns. Instead, they are more interested in ensuring that the entrepreneur’s opportunity survives long enough to ensure loan repayment. In other words, investors typically seek risk, but banks are likely to minimize risk.