As we embark on the section on structure, we find that there are two approaches the winning investors take. The winning angels are either considering the structure as essential or irrelevant (Amis & Stevenson 2001). The angels who consider the structure as essential will negotiate the deal with entrepreneurs and will not consider investing in common stock. On the other hand, the angels who deem the structure as irrelevant will take common stock, preferred stock, convertible notes, or whatever is offered (Amis & Stevenson 2001). The winning angels in this category prefer quality entrepreneurs over a structure.
Before we move on, it would be helpful to define and understand the three different structures: common, preferred, and convertible. The common stock structure is the least preferable by winning angels and is often used for family and friends. With this structure, the investor either loses all their money if the company fails or makes a lot of money, with limited time, involvement and risk (Amis & Stevenson 2001).
The preferred note with various terms offers considerably more protection to the investor and is required by VCs and many angels.
Lastly, the convertible note with various terms is the preferred structure for shorter time frames and has a very positive exit impact.
The entrepreneurs should be careful and evaluate their options with their legal team. The structure they offer says a lot about them and the deal to the angels and other investors. For example, if the agreement does not offer pre-emptive and tag-along rights, they may be considered inexperienced or having bad faith; hence, getting funding would be difficult.
The structure can also negatively impact future rounds. Warren Adams, the founder of PlanetAll and an active angel investor, suggests keeping it very simple because the venture capitalists get turned off by a complicated structure that they can’t unwind or cannot do anything with (Amis & Stevenson 2001).
Since many angels may invest based on personal connections with entrepreneurs, the pricing benchmarks may not necessarily be set based on the market-driven process but set by the entrepreneurs. In that case, if the structure lacks the normal terms such as information rights, board rights, anti-delusion, redemption rights, pre-emptive rights, and tag-along rights, the VCs and bankers may choose not to participate in the future rounds due to lack of protection.
The bottom line is, keep it simple – one-page agreement, if possible, and build reporting into the deal. The one-pager should include bullet points of key events, capital structure, salary level, and any other relevant information that will keep the investor updated and aware (Amis & Stevenson 2001).
Amis, David, and Howard H. Stevenson. Winning Angels: the Seven Fundamentals of Early-Stage Investing. Financial Times Prentice Hall, 2001.