Category: Angel Investing
Dave Balter, the CEO of BzzAgent, founder of Smarterer, and an active angel investor has a guest post up on OnStartups about his approach to angel investing. It’s titled Shorter Flights at Lower Heights: The Right Way To Angel Invest and is definitely worth a read if you are an angel investor.
I have a different strategy that has some overlap that I’ve written about at Suggestions for Angel Investors.
The bottom line for both posts is simple: Don’t act like a VC investor – you are playing a different game.
Venture Hacks has a great list of high quality angel and seed investors. I was recently added to the angel list (there goes the neighborhood) and join an active crew of angel and seed stage VC investors that currently includes Rob Go, Ariel Poler, Aaron Patzer, Jason Calacanis, Ho Nam, Georges Harik, Rob Lord, Andy Weissman, Bryce Roberts, Matt Mullenweg, Satish Dharmaraj, Brian Norgard, Mike Hirshland, Roger Ehrenberg, Peter Chane, Josh Felser, Mark Suster, Keith Rabois, Saar Gur, Salil Deshpande, David Cohen, Dave McClure, Bill Lee, Jeff Clavier, James Hong, Auren Hoffman, Jon Callaghan, Chris Sheehan, Jeff Fagnan, Michael Dearing, Dharmesh Shah, Manu Kumar, and Naval Ravikant.
There’s plenty of info listed for each person – see the example of my listing below.
If you are an angel investor or seed stage VC, please apply to be added to the list. If you are looking for angel or seed stage VC investors, have at it!
Q: I have an angel investor that is asking me for full anti-dilution protection for the lifetime of their investment, along with a host of other economic terms including dividends. They are putting in a small amount of money, but are insisting that "this is the way it is done." This doesn’t seem right – am I missing something?
A: (Brad) One of the challenges with angel (and VC) investors is that when the macro-economy is tougher and money is harder to find, terms get tougher. In many cases, especially with later stage companies, this is completely appropriate. However, it’s usually a mistake on the part of the investors with early stage companies.
In our experience, the simpler and more straightforward the terms in the angel round, the better for all parties. The entrepreneurs raise much needed capital at a fair price on terms that are easy to execute on. Equally importantly, these terms shouldn’t impede any future financings.
As an early stage VC, I’m very comfortable investing in a company that has previously raised angel money. However, I will always insist on cleaning up any angel deal that was done poorly. "Full anti-dilution protection forever" is an example of a term that should never exist. Just because an angel investor bought 1% for an investment of $25k (implying a $2.5m post-money valuation), that doesn’t mean that angel investor should have 1% of the company after another $10m has gone into the company. While theoretically this is possible to negotiate away in the next round, I’ve encountered angel investors who held up the entrepreneurs and almost killed companies over irrational terms like this, mostly just to demonstrate "how well they could negotiate." Whatever.
Another silly example is the whole notion of dividends in an early stage investment. Dividends occasionally get paid out in VC-backed companies, but only when the companies become solidly cash flow positive and have a huge surplus of cash. This is such an atypical event that they early angel investors shouldn’t be worried about it. In addition, it’s another term that will likely get cleaned up in the next round, as the VCs will likely put generic dividend language into the deal (e.g. "non-cumulative dividends of 8% will be paid out only when declared by the board", which almost never happens.)
My strong suggestion to all angel investors – regardless of the macro-economic environment – is to "keep it simple and fair." My recommendation to all entrepreneurs negotiating an angel round is to make sure you have an experienced angel investor leading the charge and helping you set terms.
Q: How do I do multiple closings on a single round work? In our case, we have an investor wishing to give us headstart, certainly I imagine not an uncommon case in friend and family scenarios, though here we’d have multiple rounds of angels, without kicking up the gears to flush out a full seed round with other investors before that money changes hands.
A (Brad): There are several ways to do this. Let’s break it into two cases: #1: You are doing a convertible debt round. #2: You are doing an equity round.
#1: Convertible Debt: This is the easiest case. For a convertible debt round, you can keep it as simple as issuing a promissory note for each investor. This promissory note can contain any special conversion terms, including what happens on a qualified financing (including the definition of the qualified financing), what happens on a sale of the company, and what happens if the company fails. You can do as many closings as you want by simply issuing a separate promissory note for each investor.
#2: Equity Round: The best way to do multiple closings on an angel equity round is to raise the early money using the convertible debt approach above with an automatic conversion into a pre-negotiated equity financing once a certain amount of money is raised. Let’s say you are planning to raise $500k and your early investor is willing to do $100k of it at a $1.5m pre-money valuation. You can negotiate the equity terms with this investor, issue a promissory note for $100k to get that money into the company, and then agree (contractually or not) to do the full round once you’ve lined up the $500k. You do run the risk that either (a) you can’t raise the full $500k or (b) some of your later investors will want different terms. If you have a good relationship with the first investor(s) you can usually manage this by including them in the process. You can also put a "most favored nation" clause in the promissory note to adjust their conversion features to match whatever the financing ends up if it is more favorable to them than the terms the negotiated.
An alternative approach to #2 is to negotiate all the equity terms with the expectation that you’ll have multiple closings on the equity round. Then, do a first closing with whatever investors are lined up and have a fixed length of time (typically 60 – 120 days) to raise more money on the same terms. Again, you should be conscious of the idea that you might have a new investor want better terms – since this is your early angel round, you should consider including a most favored nation clause so the investors that committed to you early get the same deal as later investors in the same round if the terms happen to change.
Q: I have several angels that say the want to invest but non of them wants to lead. In your experience: 1) Is this a "call option" strategy rather than a serious investment intent? 2) any thoughts on how to turn "co investors" into lead? or should I try to get a lead of this "co investors" pack?
A: (Brad) While it’s hard to tell whether this is a call option or serious investment intent, it is not that helpful in getting the round pulled together. When doing an angel round, you need two things: (1) a lead investor who is willing to negotiate terms and (2) supporting investors that won’t lead but are committed to participating on whatever terms the lead negotiates with you.
While you can’t contractually commit the supporting investors, you can usually separate the real ones from the tire kickers (or – more generously – the call option people). Committed supporting investors are going to let you use their names with potential lead investors, will engage in active networking, and will name a specific amount they are willing to invest.
These supporting investors are typically called "soft circles" – you’ve got a commitment from them, but it’s not a legally binding one. A soft circle will always have a dollar amount attached to it.
So – don’t try to convert these "followers" into "leads". Instead, try to get them into a supporting investor / soft circle mode.
I’m not a fan of convertible notes as the form of an angel investment. When I’m making an angel investment, I much prefer to price the round and do a "light Series A" (simple terms, but still a preferred instrument.) Basil Peters has a series of posts up on Angel blog that talks about the problems of Convertible Notes for Angel Investing, suggests Exchangeable Shares for Angel Investors, and even provides a One Page Term Sheet for Angel Investors.
Todd Vernon has today’s great post of the day titled Angel Financing. Todd is the CEO of Lijit (one of our portfolio companies – if you are a blogger – go check it out) and just completely nails the different types of angel investors and the issues surrounding how an angel financing works. This is a must read for anyone raising an angel round.
Q: Convertible notes are popular instruments for angel investors when a future VC round might occur. But, if it takes longer to get to the venture round than you thought (doesn’t it always?) what happens when the note comes due? Can one investor call the note and put you out of business?
A: (Jason). Yes, technically they can, but in practice this rarely happens. Normally, one of two situations exist:
1. the company is doing “okay” just behind in it’s fundraising and it will get funded; or
2. the company is not going to get funded and it’s realistically done.
In case one, the investors would be irrational if they called their notes, as they would get pennies on the dollar (remember the company is spending their money along the way) and preclude any chance of funding and thus them getting an attractive return. Even in cases where funding seems remote, most of the time investors will give the company the maximum opportunity to get funded and continue on.
In case two, the company is going to shut down probably, so it’s probably not too traumatic to call the notes. In any event, the investors will get back pennies on the dollar, so it’s still in the best interests of the investors to let the company run as long as possible before throwing in the towel.
One thing to note: don’t personally guarantee angel notes. In that case, the calling of the notes will attach to the entrepreneur’s personal assets and may indeed incentivize investors to call their notes sooner than later.
David Cohen – the ringleader of TechStars – has a good post up titled Thoughts from the west out east, and vice versa. Last week David was a guest speaker at the Northeast Regional Investor Conference held in Portsmouth, NH. In addition to running TechStars, David is an active angel investor in Colorado and had a very interesting reaction to the way “better angel groups – both east and west coast – worked.”
“One thing that I heard repeatedly today from the better angel groups (east and west) is that every single deal that is presented to their group is sponsored by one of their members. That member introduces the deal before the pitch. I got to see 3 “quick pitch” deals today and they were all high in quality. They were effectively introduced by the sponsor angel. If the deals weren’t good, that angel would look bad for bringing the deal to the group. Social pressure was at work naturally and effectively because of this simple rule. No screening committees, application fees, etc. Just go impress a member angel. We should be able to learn from these best practices in Colorado, but we haven’t. Both Kieretsu and CTEK require applications, payment of fees, and artificial screening processes. Just make them get to and impress an active angel who is a respected member of the group. Much cheaper, no fees required, and good dealflow. If they can’t find and impress just one angel enough to get there, there’s a 99% chance they shouldn’t be there anyway. I continue to hope we see this sort of model adopted with Colorado’s angel groups. It’s certainly the way many of the very high quality angel deals get done outside of those groups already.”
Read the rest of the post for what David found offensive and then – on second thought realized was correct.
Q: I’m CEO of a venture backed startup. In addition to my VCs, I have about 20 angel investors from the Series A round. What is the appropriate way to handle information requests from smaller angel investors who want copies of my board presentations and monthly financials? These angels do not have information rights, but they are requesting the courtesy of receiving the same materials I provide my VCs. They are willing to sign NDAs, but I’m nervous about forwarding electronic copies of sensitive materials.
A: (Jason) This is an issue that all angel-funded companies have to deal with and while there is no “right” answer, there are some general guidelines to follow. First of all, regardless of what the documents say, you want happy investors and you do owe them some information. That being said, it’s probably not the same information that the Board receives.
I think that you can justify giving the board different information for two reasons: One, the board has duties of care that mandate it taking a more in-depth look into the company to comply with these duties and two, board discussions (if attended by the company’s lawyers) are protected by attorney-client privilege. If you were to pass out the board materials to your angel investors, it’s arguable that you’ve waived the privilege.
Given your amount of angel investors, I’d consider putting together an alternative information packet which would include a cover letter, some business updates and financials. I would think that quarterly updates should suffice. This could easily be PDF / email / hardcopy, whatever you feel most comfortable with. You could also choose to do a conference call with your angel investors every so often and let them ask questions. Note, however, that this format can turn into a “free for all” and I’d be cautious in using this approach.