Welcome back Blog readers! Amis’s and Stevenson’s (2001) information, regarding angel investing, in their book Winning angels: The seven fundamentals of early-stage investing will be part of my Blog post again as we learn valuable insights together. I will be sharing information in this Blog from Amis and Stevenson (2001) about Structuring.
Koss (2007) states, “Structuring the deal is a key aspect of completing an angel round of financing. It is critical to ensuring that management, employees, past investors, current investors and future investors are all satisfied with the company under its new capital structure. As a result, negotiating and structuring the deal can be the most complex aspects of angel investing” (p. 1).
Lets explore some details about structuring…
What options exist?
Here are a few options:
Three common ways to structure angel investments include: common stock, preferred convertible with various terms, and convertible note with various terms.
According to Amis and Stevenson (2001) the common stock structure “…is the ‘complete faith’ option, which is used most often by family, friends, and fools as well as winning angels who rely more on the integrity of the entrepreneur as well as their own ability to source or evaluate” (p. 190). Some angel investors, especially those that have lost money on common stock structure deals, refuse to have any part of common stock structures and there again some angel investors will (Amis & Stevenson, 2001). Amis and Steven (2001) note that with the common stock structure, in the best case scenario, an angel investor can make a substantial amount of money without having to invest their time and involvement or in the worst case lose their entire investment. Amis and Stevenson (2001) note that a preferred convertible with various terms structure is most common. Amis and Stevenson (2001) states, “The preferred share structure offers considerably more protection to the investor and this is why…many angels come around to using it” (p. 192). Lastly, regarding the convertible note with various terms structure, Amis and Stevenson (2001) state, “The convertible note is becoming a more common vehicle as financings are occurring in shorter time frames” (p. 193). These are certainly some structuring options. Amis and Stevenson (2001) give some final thoughts on structuring which include: keeping things as simple as possible and making sure that you understand these three structure types.
Finally, to finish up this Blog post on structuring, it is important to note that Koss (2007) gives several examples of “warning bells” or “red flags” regarding structuring deals. Koss (2007) states, “There are some red flags that investors should watch out for. Are there any unknown investors? Is the term sheet too complicated or inappropriate for the nature, context and stage of the company? Is the company raising enough money? What’s the possibility of dilution (p. 9)?” I highly recommend reading through the entire list of “warning bells” and “red flags.”
To read the entire article by Koss (2007) please click the following link:
Thanks for reading and good luck on finding investors and structuring deals for your new venture!
References
Amis, D., & Stevenson, H. H. (2001). Winning angels: The seven fundamentals of early-stage investing. London: Financial Times Prentice Hall.
Koss, A. (2007, July). Best Practice Guidance for Angel Groups – Deal Structure and Negotiation. Retrieved May 22, 2019, from https://www.angelcapitalassociation.org/data/Documents/Resources/AngelCapitalEducation/ACEF_BEST_PRACTICES_Deal_Structuring.pdf
“As a result, negotiating and structuring the deal can be the most complex aspects of angel investing”…. I think that statement taken from your narrative sums up this section on Structuring quite well. As I read through pages 178-222 of Winning Angels I was thinking to myself “Wow, this is confusing”…. and your statement “can be the most complex”…. YEP !!! I will spend time researching and trying to understand the difference between common stock. versus Preferred Convertible with terms versus Convertible note with terms. Surely sounds like typical water cooler banter, doesn’t it?
Kay,
It seems the options are plentiful when angel investing. I am sure much of the decision making process becomes easier as time moves forward. As an outsider looking in, it seems to be a difficult process to decide which structure to choose. I believe angel investing looks easier on paper, but is challenging in practice. I read over your source and I found the following interesting; It takes 18-24 months for an investor to simply experience a normal cycle of angel investing. At that point, investors start to see their losses. In their enthusiasm, they may have over invested. Then they suddenly say, ‘Why am I doing this?’ They are now ready to make investments but they usually get out, unfortunately (Koss, 2007). Angel investing must take quite the toll on the “first timer.” I enjoyed your post and I will talk to you soon!
– Paul
Kay,
You did a fantastic job summarizing the key ideas of structuring. I agree with Michael on how confusing it might be to figure out which option is best. My approach as been to look at the materials/readings in front of me and see “how this fits to my business project(s)” and surprisingly there has always been a choice that seems to “speak” to me. In this case, common stock seemed to be the best fit. I think it offers enough flexibility and little restrictions for future funding rounds. I also remember reading about how it is the typical structure found among early-stage investment deals. What did you think about these three options, did you have a preference?
Best regards,
-Jose
Kay,
Very nice recap. While each section has been providing opportunities to go down rabbit holes of options and information, this one speaks directly to the relationship tied to financials. I like that you called out the warnings and red flags. It is always important to evaluate the positive and negative. The section I feel was very appropriate was on being ready for failure (pg 197). The honest recognition of situation and risk for an investor is key. Like the value self-awareness for an individual, the same applies to investors involved in business.