1. Angel Investing 202: The Mechanics of Investing
Investments over time
Investment instruments
Valuation examples
Tax considerations

2. Not all companies do all these things.
Investments Over Time
Amounts raised
$ $x0, $x00, $xx,000, $xx0,000,000
Exits
Bootstrap
Friends and Family
Angels
Venture
Capital
IPO
Crowd Funding
Strategic
Investors
M&A
Kickstarter
Grants
Time
Not all companies do all these things.

3. Type of Investment by Stage
Bootstrap
Pre-Seed/Seed
A > B > C ...
IPO or M&A
Founders
Common stock
Typically few additional shares
Shares become liquid
Employees
Common stock option grants. Option pool may increase over time.
Can exercise options & then have liquid common stock
Investors -
Often convertible debt, SAFE, or royalty based funding
Typically preferred stock
Preferred converts to common

4. Preferred Stock Successive priced rounds: Series A/B/C….
Often a VC-led round where VCs typically expect Delaware C-Corp
The marketplace (investors) sets the price/share
Don’t bother with net-present-value calculations
If investor wants 25% ownership for $1M investment:
The pre-money valuation is set at $3M
Assuming 750,000 shares/options were previously issued, then with $1M investor buys 250,000 shares at $4/share
Price/share can be higher or lower than in previous round
“Down” rounds are terrible for existing investors

5. Preferred Stock
Preferred stock holders have rights that common stock does not have.
Most notably, upon acquisition investors have the option to get 1 to 2 times their investment back before common gets anything
If a company raise $3M and get acquired for $2M than common stockholders may get nothing
The preferences are why investors pay more per share than stock option strike prices
CEO

6. Convertible Debt
Does not require a pre-funding valuation to be defined for the company
The loan automatically buys series A preferred stock when A is issued, at better terms than the series A investors receive
Is basically unrecoverable if the company fails

7. Convertible Debt – Key Terms
Interest rate
Earns interest which is used to buy stock at Series A conversion
Typically 3% to 8% annually
Discount rate
The discount from the Series A preferred price
Typically a 20% discount
Valuation cap
More on pre- and post- investment valuations later, but
Protects the percent ownership position at conversion time
Conversion trigger
Typically = series A of a certain size
Can also be a set date

8. SAFE - Simple Agreement for Future Equity
Similarities to Convertible Debt
Differences from Convertible Debt
Both convert into equity in a future priced equity round
Both can have valuation caps and discounts
SAFE is a warrant to purchase stock in a future priced round security
Is not debt; no interest is earned
A convertible note typically has more conversion triggers than SAFE
Protection for investors

9. Royalty Based Funding: Lower risk/lower return for investors
A loan repaid with % of revenue
Assumes company has both revenue and positive gross margins
An example
Raise $250k
Cap (return to investors) = 2 to 3 times the amount raised
Pay back 5% of gross revenue until cap is reached
A flexible instrument
Sometimes includes stock warrants

10. Founders Common Stock
Ownership goes from 100% at bootstrap to maybe 30% at IPO
A small slice of a huge pie versus owning all of a very small pie
Typically investors expect a four-year vesting schedule
Stock is typically not sellable until M&A or IPO

11. Employee Stock Options
Typically uses a four year vesting schedule
To protect employees, stock option grants must follow strict legal and IRS guidelines

12. Opportunities for post-investment company involvement
Board of Directors Membership
Likely possible if SWAN has led the deal (set the deal terms for all investors) and has invested a material amount of money
Comes with legal governance responsibilities and associated legal risks
Advisory Board Membership, Mentoring, or Consulting
Possible if an investor has expertise helpful to the company

13. Valuation, Dilution, Return Example: Angel 10x return.
Every round has a higher stock price (up rounds)
Input Cells
Download spreadsheet at

14. Angel 0.5x return example.
Company survives but struggles during A and B. Series B is a down round.
Employee option pool increased to retain employees.
Angels dramatically impacted

15. Half of angel-funded start-ups will return $0
Dilution concerns and SAFE vs. Debt don’t matter
The important question: Can company grow to ~$40,000,000 in revenue and get acquired?
If that growth happens, Debt vs. SAFE and detailed terms don’t matter very much.
Dilution is significant (valuation cap/pre-money)
For a struggling but surviving company
Debt vs. SAFE and detailed terms can make some difference, but the absolute value of any financial return will likely be small

16. Tax considerations: Laws can change yearly. Consult a tax attorney!!!!
QSBS:
A Qualified Small Business Stock. is a domestic C Corporation in which the aggregate gross assets of the corporation at all times up to the time of issuance do not exceed $50M
Section 1202
Can exclude 100% of QSBS capital gains from taxes if stock (not convertible debt) is held for five years
Section 1045
Capital gains can be avoided if you put all of the gains from a QSBS in a new QSBS investment within 60 days
Section 1244
If your investment is part of the initial $1M invested in a QSBS company, the loss can be used to reduce your earned income (vs. reducing capital gains)

17. A Good Resource