You will be asked “how are you structuring the deal?”. What does this mean?
Angels are asking:
- What are their investment terms? What type of financing will they provide equity or debit? Will the investors get their cash back before the company does? And, will the angels have the right to invest in future business opportunities with you?
- What role will the angels play in your company after they invest? Will they be silent investors, active ones or something in between? Describe their duties and responsibilities.
Angel investment structures vary, but they typically invest in one of three types of securities: Common Shares, Convertible preferred shares, and Convertible debt. Wait – What? What does this mean? Let’s define some of these and see what you need to know about each.
Are residual value shares of the same class issued to a company’s founders. This is the simplest but provides few safeguards to the investor.
Convertible Preferred Shares
Is more complicated but can benefit the investor to a greater degree. Convertible notes allow no negotiation on price but offers angels the most protection. It’s all negotiable, but the time to negotiate is before the term sheet gets signed.
Angel investors often invest through convertible debt. This involves the investors loaning money to the company, with the loan amount being convertible into equity shares of the startup.
The advantage of this structure is that the parties involved can defer fixing a valuation on the enterprise until future financing is set. When the financing is done, the debt converts into equity shares at the purchase price, sometimes with a discount to reward the angel for investing early.
Make sure you do your homework and have a plan for this step of the angel investments. You want to be prepared on every level!
David Amis-Howard Stevenson (2001). Winning angels: the seven fundamentals of early-stage investing. Pearson Education.