1. Angel Investing 202: The Mechanics of Investing
Stages of Investments
Investment instruments
Industry Data
Valuation examples
Post-investment activities
Tax considerations

2. Not all companies use all these stages.
Stages of Investing
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
Private
Equity
Grants
Time
Not all companies use all these stages.

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, KISS or revenue based funding
Typically preferred stock
Preferred converts to common

4. 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

5. 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

6. Comparing Early-stage Options
Structure
Equity mechanism
Has a discount
Has valuation cap
Earns interest
Has Maturity Date
Convertible Note
Conversion at date or TBD equity round 
Keep It Simple Securities: KISS/debt
Conversion at 18 months or $1M equity round
KISS/equity X
SAFE - Simple Agreement for Future Equity
Warrant
Increasingly Investor friendly

7. 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

8. Revenue-based Funding
Investors loan money to company
Company repays investors with interest by sharing a percentage of revenue
Benefits to company
Company does not give up equity [non-dilutive]
No M&A pressure from investors [no exit required]
Repayment amounts scale with revenue [no fixed monthly payment]

9. Typical Mechanics Amount raised 25% to 33% of annualized revenue
Repayment rate
4% to 8% of revenue
Total repaid
1.5x to 2x the amount raised
Typical repayment period
3 to 5 years
Examples:
Monthly revenue
$20k
$100k
Annualized revenue
$240k
$1.2M
Amount raised
$80K
$400k
Amount repaid
$160k
$800k

10. Can Work Well When Company has revenue Revenue is growing
Company has positive gross margins
Payment amounts are tolerable

11. An Alternative Revenue-based Financing Model
Hybrid of Loan and Equity
Investment dollars initially buy equity
Company buys back half of the equity from investors over time by paying investors 5% of gross income

12. 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

13. 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

14. Preferred typically get to approve:
Change the primary business of the company
Annual budgets, business plans, and financial plans
Hiring of all officers
Compensation for officers
A merger or acquisition
Liquidation, wind-up or dissolution;
Increase or decrease the number of directors
Standard company employment agreements
Equity incentive programs as well as issuance of all stock and stock options
Paying of dividends
An increase in the authorized number of shares
Real estate transactions
Capital equipment purchases greater than $500,000
Debt in excess of $500,000

15. Industry Data

16. 2017 ACA Data - Round Size and Median Overall Valuation
Total Amount Raised
Per Round
Pre-Money Valuation
or Cap on Note
Nearly 60% of the total investment rounds were $1M or less, with a median size of $1M.  The dataset includes some larger investments, however, with 9 deals of $10M or more (all follow-on rounds), and 16 deals between $5M to $10M.
The median pre-money valuation or cap on a convertible note was $5M, with a wide distribution of valuations.
Median Round Size = $1M
Median Valuation = $5M

17. 2017 ACA Data - Valuations Change by Round Stage
Pre-Money Valuation - Angel Round
Pre-Money Valuation – Series A Round
The median pre-money valuation or cap on a convertible note was $5M, with a wide distribution of valuations. The valuation levels change depending on which series the investment is made in.  In the Seed/Angel Round, the median pre-money valuation was $4M, with 46% of groups reporting valuation between $2.5 and $4.5M.  Many angel groups invest beyond the Seed Round.  In the case of Series A deals, the median pre-money valuation was $8.5M.
Median Valuation = $4M
Median Valuation = $8.5M

18. Median pre-money valuations ($M) for rounds less than $1M

19. 2017 ACA Data – Company Status
Revenue at Time of Funding
Number of Employees at Time of Funding
Company Detail:
The initial data provides insights into the sizes of angel group portfolio companies, which are typically smaller companies based on revenue and number of employees.  At the time of investment, nearly half of the companies were pre-revenue, although about 6% of the companies had revenues of more than $3M.  The companies had small staffs, with a median of 7 employees, but some companies had revenues above $10M and 100+ employees.  In terms of tax structure, the bulk of the startups were C Corporations, followed by Limited Liability Companies and S Corporations.
Tax Structure

20. Valuation, Dilution, Return Example: Angel 7x return.
Every round has a higher stock price (up rounds)
Download spreadsheet at

21. 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

22. Post-investment Activities
Receive quarterly reports for company
Involvement opportunities
Board of Directors seat
If we led the deal and invested significant amount.
Has some legal risks.
BoD Observer
Attend board meeting but don’t vote on board resolutions. No legal risk
Formal Advisory Board seat
May include stock options
Mentor / informal advisor
Not compensated
Paid Consultant
Unusual

23. 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)

24. A Good Resource

25. Consider taking the Angel Investing 201 class

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