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Angels – Keep It Simple and Fair

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.

December 19th, 2008 by     Categories: Angel Investing    
  • http://ventureswell.com LukeG

    Y Combinator and Wilson Sonsini have “open sourced” a strong and simple set of funding docs for pre-Series A investments. The “Series AA” details are available at http://ycombinator.com/seriesaa.html.

    (We do love TechStars, too.)

  • Knox Massey

    Amen to your post.

  • Prefer nameless

    So, we are to take this to mean:
    - You have no anti-dilution protection in your VC deals
    - You don't ask for dividends on your VC investments
    - You use the same docs that you referred us to in your own investments (Really?)
    - You really use the same docs, and terms and conditions you suggested from Wilson Sonsini, which is beholden to VC's, not angels and certainly not entreprenuers (Certainly not the docs I've seen in my vc deals)
    - Angels who take the early risk are not entitled to the same terms and conditions VC's get?

    Hmmmmmmmmmmm

    • http://www.feld.com Brad Feld

      I’ve done many angel and seed round investment with my own money. I’m perfectly comfortable not having anti-dilution or dividends in these investments.

      When I do seed investments as a VC (usually $500k to $1m), I use what I call a light preferred. It has weighted average anti-dilution and non-cumulative dividends. Simple, standard language. I include this since I always inherit it into the next round of financing (past the seed investment).

      When we publish the TechStars documents (which should be shortly), you’ll see that we use similar terms (although they are Cooley docs instead of WSGR docs). We are also in the process of putting together standard seed docs for VC investments which we are considering publishing (which would also be appropriate for angel investments.)

      I think the base point is to keep it simple. Weighted average anti-dilution is fine (but probably doesn’t matter much in an angel / seed deal); full-ratchet anti-dilution is overreaching and sets a bad precedent for future rounds. Dividends – well – they are just a waste of paper (including non-cumulative dividends.) They are now an artifact of 1,213,103 financing documents, but someone should finally decide they should go away. And – actual dividends (cumulative OR annual pay dividends) in a seed deal are just ridiculous.

      • http://www.liebermanlaw.com Saul Lieberman

        I'm with Fred but I'd like to make one further point. “Full anti-dilution protection forever” of the kind that maintains the same % forever is never demanded by VCs and is vastly different from “full ratchet anti-dilution protection” (which is sometimes demanded by VCs).

        “Full anti-dilution protection forever” would be triggered every time the company raises $, even at successively higher valuations, and has no justification.

        Companies would probably be better off using a substantially lower valuation if that is what it takes to avoid this kind of protection. Sometimes running the numbers for hypothetical future rounds with “full anti-dilution protection forever” and comparing it to raising $ today at a lower valuation (sometimes 50% lower) without such protection is enough to soften the demand.

        • saul

          yikes. that's Brad, not Fred!

          • http://www.feld.com Brad Feld

            That’s ok. Fred and I are often confused!

      • Jason Taylor

        “I’m perfectly comfortable not having anti-dilution … in these investments.”

        I’m totally ignorant of the issues here, so I should probably read more before posting, but what is the best document or book that goes over this this issue in more detail one might recommend?

        Not ever having seen any of these documents, I’d like the book to answer why any angels would be taking what seems like high risk to buy x% of a company, when, if lucky, VCs are going to come in with relatively low risk to say, sorry that was only y%, where y% is a random number less than x%? What, exactly, are the angels buying? Is it the good faith the CEO will want to avoid them getting diluted to nothing?

        My apologies in advance for asking such basic and ignorant questions and many thanks for any specific book suggestions.

  • Shaun

    I am just about to present my company to a group of investors… between the whole group I am probably looking to raise about 150-200k. This will be a seed/angel round and I'm optimistically hoping it's the only round of capital I will need.

    I was actually considering offering dividends to make the investment a little more attractive. Just to make sure, you're saying this is not a good idea, correct?

    • http://www.feld.com Brad Feld

      I think dividends on an angel round (or pretty much any early VC-type equity financing) are unnecessary as they almost never get paid out. They’ll only get paid if the company becomes profitable and then the board / shareholders can declare a dividend anyway, regardless if they are in the financing docs.

      Unless you plan to become profitable on $200k, then the construct doesn’t really make any sense.

  • Dave

    When raising angel money, always remember to set the approval thresholds for future financings and waivers at a reasonable level. Particularly if you raise money from a bunch of angels, those thresholds are important and keep you from getting held up in raising new money. Too often people set thresholds at 75% or some ridiculous percentage that allows one unreasonable angel (seems like was always a Doctor in my financings) to hold a financing hostage.

  • Claudio Torres

    Hi, I am the CEO of a new brazilian company we are building for Space Market ( Low Cost Launch Veicles, Small and Cube Satelittes ). We are planning the first angel round. I was wondering if it is necessary to plan all the rounds from now or if we go for the first and them define the other $ raising during the journey ?

    • http://www.feld.com Brad Feld

      It’s not necessary to define all of your future rounds. While it’s typical to state how much money you think you are going to need over the life of the company to become self-sufficient (e.g. cash flow positive), it’s highly unusual to break this out by financing since whatever you think today is probably not correct anyway.

  • http://www.reiboldt.com Mark

    Take this “angel's” terms and throw them in his/her face, right before walking away for good. Okay, so don't be a jerk and do that, but take it from me and the others that this is an absurd request, and no it isn't “how it is done.” Brad is correct to point out that later stage VC's will correct any poorly structured angel financings. There is no such thing as an “anti-dilution clause” – are these people from Russia or something?!? What amateurs! Angels have very little leverage whatsoever, even though they think they do because at that stage, the start-up is typically in dire need of cash. Either way, those early on individual investors will rarely have a real role in the long-term progress of the company – they are more or less just along for the ride.