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.