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How Does A Small Angel Investment Impact a Future VC Round?

Q: Say I have an angel (SEC accredited) who’s ready to invest at an amount well below $100k. How would this impact on a future round with VCs? Is there some standard or average pre-money and post-money that happens in angel deals? Also, the angel in question is a family member of a friend, so would it be better to have them invest as a family/friend financier rather than an angel, and how exactly would that work?

A: (Brad) Let me address the last question first.  There is no real difference between a "family/friend" investor and an "angel" investor other than semantics.  Structurally and functionally they are doing the same thing.  Now – there might be an emotional difference when you have to see your "family" at Thanksgiving, but that’s it.

Regarding how a VC will view this, sophisticated VCs are used to having angel investors as early investors in your company.  Your life will be made easier if you treat the angel investment as a real investment and document it legally as such – I’ve written about this in What’s The Best Structure For A Pre-VC Investment

Insuring that your angel investors are accredited is important as this is likely one of the things that will matter to the VC.  If your angels can be specifically helpful to your company (because of their background / experience in companies similar to yours) you should make sure the VCs know about them.  In addition, you should try to enlist your angels in getting you connected to VCs that they know and have worked with.

Finally, there is no standard pre-money/post-money in angel deals.  We typically see pre-money ranges between $1m and $3m for angel deals, but they occasionally go higher and sometimes go lower.  Be careful not to price the angel round too high as the VCs are going to likely ignore the angel round pricing and – if they price their round lower – it can be a difficult conversation with the angels who supported you early on.

March 24th, 2008 by     Categories: Fundraising    
  • Ken Feldman

    You might also consider doing a convertible note with a discount on the Series A round (generally your first VC round).

    The mechanism works like this. Your angel investors put up $100K, they get a convertible note with a 25% discount on the next round (25% – 40% is common), plus generally some interest (6-8% is common). If in your next round you sell shares for $4, your angels investment automatically converts into common stock at $3. If you sell shares at $2, it converts at $1.50.

    Convertible notes are all upside for your angels, and almost no downside. It means that no matter what happens, they get their stock at a lower valuation then the next investor.

    Notes can also be very creatively structured:

    - Timers, where after X months the % changes. For example, if after 6 months you have not closed a Series A of at least $1M the discount goes from 25% to 35%.

    - Cap on the maximum valuation. Let's say you company has a pre-money valuation in the Series A of $3M and the VC invests $1M, the VC gets 25% ownership at a $4 stock price. ($1M out of a total value of $4M is 1/4 = 25%) Your convertible note holders would get their shares at a 25% discount, so their shares cost $3. But what if your next round is pre-money of $10M? The VC puts in $10M, they own 50%, shares are selling at $20. Your angels get their shares at a 25% discount, or $15. Ouch. Not such a good deal. By putting a cap of $5M as the maximum valuation, they get their shares for $5, or a 75% discount. Much better deal. (This is just an example folks, trying to make the math easy)

    Their is only one downside to notes – explaining them to unsophisticated investors. Convertible notes are very common in the Valley, not so much outside. You need to present this as a way to protect them. They are taking the biggest risk, so that no matter what they get a better deal then the next guy. Also, leave the maximum valuation out of the deal unless someone brings it up. If you mention it, investors who have limited experience with notes will generally fixate on the valuation cap and assume that is the conversion price and start thinking that is what they are going to get their stock for. Not good.

    Happy hunting!

  • http://www.angelblog.net/ Basil Peters

    In my opinion, convertible notes are almost never fair to the angel investors. The challenge is that any psychologically acceptable discount will not be adequat to offset the additional risk being assumed by the angels, who are investing earlier, and the uncertainty of the timing of the next round. I have done my best to describe the math and psychology at http://www.angelblog.net/Convertible_Note.html. I hope this helps. Basil