In continuation of my angel investor series, this week I am going to talk about structuring. The first important item to know is that winning investors do not always agree on structuring of a deal. Some angels believe that structure is essential and will take a hands-on approach to negotiating structure. They might also be evaluating the deal based off the proposed structure of the deal. These angels are very likely to put their mark on the price and the deal structure.
Angels who are a part of the other school of thought believe that structure is irrelevant. They will simply take whatever is offered whether it is common stock, preferred stock, or convertible notes. These angels will make their judgements whether the deal will succeed or be a beautiful failure. They know that if it succeeds, they will do just fine without any protections. If it fails, the salvage operations will not be worth their time or energy.
Angels use various structures when investing and there are three that are used the most often which are:
Common stock- this option is offered by angels who rely on the integrity of the entrepreneur and their own ability to source and evaluate the deal they are making. This structure is the most simple and it has its advantages. You want to use this with someone that you know is reasonably sophisticated and they are a quality person.
Preferred convertible with various terms- this option is common among venture capitalists and countless angel investors. “This structure is not that simple and will require some significant interaction with the entrepreneur in the hoped-for event that additional capital is raised or an exit obtained.” (David and Stevenson, 192). This structure also offers more protection to the investor than common stock, which is why we see so many venture capitalists using it.
Convertible note with various terms- this option is becoming much more popular in fields where things move much faster and there is shorter periods. This structure will require interaction with the entrepreneur but it can be simple interactions. Venture capitalists are not the biggest fans of this structure because they do not like if the percent discount is high.
give some simple rules that you should follow when planning the structure.
1.) Keep it simple- this will ensure that everyone can understand the structure and it will not limit the management team’s abilities and aid new investors to come to a new deal in a reasonable amount of time.
2.) Do not restrict the company’s ability to do future deals- You should avoid restrictions on future dealing that you put in place to protect yourself against value discrimination or unreasonable dilution. You will only harm yourself.
3.) Make sure the valuation is reasonable- Do not set your first valuation high because you will run out of gas right out of the gate and additional investors will not want to come in during the first round. You also run the risk of the old investors and stock-holding employees to be unmotivated if you come back at a better rate.
I think this was my favorite section so far that we have read. I found it very interesting and loved learning about how to structure your deal, both as an investor and as an entrepreneur. I think the rules were very helpful and I found it witty how the authors gave you the deal terms as a menu on pages 185 through 188. What structure would you go for as an investor? What about as an entrepreneur?
Thank you for stopping by and reading my blog.
Until Next Time,
Amis, David, and Howard H. Stevenson. Winning Angels: the Seven Fundamentals of Early-Stage Investing. Financial Times Prentice Hall, 2001.