ENT (640) – Winning Angels: Structuring

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).

References:
Amis, David, and Howard H. Stevenson. Winning Angels: the Seven Fundamentals of Early-Stage Investing. Financial Times Prentice Hall, 2001.

8 Comments

  1. Semir,
    Great post! I agree, the structure being offered does say a lot about them and the deals with investors/angels. When it comes to business investments, most people want a structure that proves experience and knowledge. Although, some investors may be willing to take a chance on structure that doesn’t have much experience based on possibility of the business becoming highly successful and profitable. Keeping it simple is one of the most important aspects when it comes to business investments/transactions.

    1. Audrey,
      Thank you for stopping by and leaving your valuable feedback. I believe structure should be essential for any business especially when attempting to raise funds. Having a structured deal and keeping it simple should be a bare minimum any serious entrepreneur should abide by. The deal should be mutually beneficial especially if the business becomes highly successful. After all, the only way it can get there is through the funding of angels and VC’s.

  2. Semir,
    Great post! I agree, the structure being offered does say a lot about them and the deals with investors/angels. When it comes to business investments, people want a structure that proves experience and knowledge. Although, some investors may be willing to take a chance on structure that doesn’t have much experience based on possibility of the business becoming highly successful and profitable. Keeping it simple is one of the most important aspects when it comes to business investments/transactions.

  3. Before reading this section of the book, I had not considered how your up front structure could impact future investment opportunities. It is extremely important to keep that in mind as you build out your structure during the first rounds of investment. You need to keep it simple, and always remember that these investors are looking for a turn-around profit. The name of the game is getting a good return, in a reasonable amount of time. I think this has always been a bit of a stumbling point for me. I have always thought of business ventures as long-term projects. But, for most angel investors, they want a clear exit strategy. And they like a 2 to 3 year term instead of a 20 to 30 year one.

    1. Colby,
      Thank you for the feedback. You are spot on. This class and this book is actually my first experience with Angel Investing. I did not realize there was a distinction between the angel, the VC, and a regular investor such as the bank. However, as we see throughout this book, the angels and VC’s usually want a short ROI and a quick exit strategy. I still don’t see how such structure would work for a business that is not planning to go public or to sell within 2-3 years. I don’t think the angel investors would be interested in such a deal.

  4. Semir,
    Great post! You did a great job directly explaining the various structure that can be used in making a deal with so little words! I agree with you about knowing what these structures mean as an entrepreneur. The last thing you is to be going back and forth and potentially scaring off investments because you aren’t knowledgeable enough to know what people are looking for or coming off as too greedy or stubborn!

  5. Semir,

    Excellent post! I had a hard time digesting the reading, but your reflection helped me understand it better. Keeping it simple has been a common theme in life. Sounds like structuring is no different in the case of investing. I think structuring is difficult for me to think about at this stage because there are so many other components to a business that I would focus on, first. For a company that plans on being multi-million or multi-billion dollar company should spending a considerable amount of time deciding if they want to create a structure or not.

    Regards,
    Elaina

  6. Semir, I think you did a great job of breaking down structure.

    What I find most complicated to understand about structuring is what you mentioned at the end: structuring a deal with concise details, but in a short handed way.

    Maybe I am just long winded, but it is hard for me to capture a lot of details while also being explicit in my language. I guess it is a gentle balance of being concise, yet flexible.. It also illustrated to me the importance of why everyone should know their non negotiables. I suspect that the more you know about what you’re not willing to be flexible on the easier it is to keep your language concise and to weed out things that aren’t necessary for the deal structure.

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