1. Angel Investing 202: The Mechanics of Investing
Stages of Investments
Investment instruments
Industry Investment Patterns
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 & have liquid stock
Equity Investors -
Often angels & convertible debt, SAFE, KISS
Typically VCs & preferred stock
Preferred converts to common
Non-equity Investors
Angels revenue-based funding

4. A Key Concept - Valuations
Pre-money company valuation ($2M)
plus
Investment amount ($1M)
equals
Post-money company valuation ($3M)
Result: Investors own 1/3 of the company

5. Convertible Debt Does not require a pre-money valuation to be defined
The loan automatically buys series A preferred stock when A is issued, at better terms than the series A investors receive
Debt is unsecured (unrecoverable) if the company fails

6. 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
Puts a cap on the series A pre-money valuation used for the debt conversion calculation
Protects the percent ownership!!
Conversion trigger
Typically = series A of a certain size
Maturity date
Repayment

7. What is a Typical Convertible Debt Valuation Cap?
Depends on every aspect of business plan
Team, traction, technology, market size, IP, sales challenges, competition, etc.
That said, annualized revenue rate (ARR) is a strong determinate … at least in Texas!
Likely valuation caps
Pre-revenue
ARR < $100k
ARR < $500k
ARR > $1M
$1.5 to $3M
$2.5M to $4M
$3M TO $6M
$5M to $10M

8. Comparing Early-stage Options – there are variations for each type
Structure
Number of versions
Equity mechanism
Has a discount
Has valuation cap
Earns interest
Has Maturity Date
Convertible Note (traditional)
No standard
Conversion 
Keep It Simple Securities: KISS 2
varies
SAFE - Simple Agreement for Future Equity 4
Warrant to buy X
Increasingly Investor friendly
More detail and nuance at:

9. Dilution is significant (valuation cap/pre-money)
The important question: Can company grow to ~$40,000,000 in revenue and get acquired?
Half of angel-funded start-ups will return $0
For these companies: 15% vs 20% interest rate – who cares?
Dilution is significant (valuation cap/pre-money)

10. 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]

11. Typical Mechanics Amount raised 25% to 33% of annualized revenue
Repayment rate
4% to 8% of gross 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

12. Revenue-based Financing can make sense when
Company has revenue
Revenue is growing
Company has positive gross margins
Payment amounts are tolerable
Uncertain exit potential

13. A Different Revenue-based 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

14. Preferred Stock Successive priced rounds: Series A/B/C….
Typically: VC-led and a Delaware C-Corp
The marketplace (investors) sets (maybe negotiates?) the price/share
Price/share can be higher or lower than in previous round
“Down” rounds are terrible for existing investors

15. Why is it call “Preferred”?
Preferred stock holders have rights that common stock holders lack
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

16. 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

17. Industry Investment Patterns

18. 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

19. 2017 ACA Data – Valuation 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

20. 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

21. 2017 ACA Data – CEO Profile

22. A Brief Look at Cap Table and Valuations

23. What to Look For in Cap Table - Employees
Option pool of 10 to 15% for new hires
In pre-investment cap table
Vesting schedule for all founders
CEO has more shares than co-founders

24. Valuation, Dilution, Return Example: Angel 7x return.
Every round has a higher stock price (up rounds)
In this example:
Seed round is led by angels ($600k) using convertible debt
Angels have no ownership
No valuation is set

25. Valuation, Dilution, Return Example: Angel 7x return.
Every round has a higher stock price (up rounds)
In this example:
Series A equity investment by VCs ($3M and $2/share)
Pre-money of $6M and post-money of $9M
Option pool increased
Debt converts with discount and interest and angels own 13% of $9M, with share valued at $1.18M

26. Valuation, Dilution, Return Example: Angel 7x return.
Every round has a higher stock price (up rounds)
Series B and C have higher price per share
Series B & C have a pre-valuation which is higher than previous round’s post- valuation
Option pool is increased to keep employees engaged
After series C, angels own 7% of $60M, valued at $4.2M

27. 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

28. Post-investment Goals
A wildly successful company
Company closes their entire round
CEO receives the most-needed assistance
Good ongoing two-way communication between company and investors

29. 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

30. 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)

31. A Good Resource

32. Consider taking the Angel Investing 201 class

33. Consider taking

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