ENT 640: Winning Angels: The 7 Fundamentals of Early-Stage Investing

ENT 640 Week 5: Structuring

There are three main fundamental structures that are involved in angel investing according to the book Winning Angels: the 7 fundamentals of early stage investing. The first main structure is common stock. This relies on the entrepreneur being able to source and evaluate. It is key to make sure the entrepreneur is very knowledgeable and experienced. “This is the ‘complete faith’ option, which is used most often by family, friends, and fools, as well as winning angels who rely more on the integrity of the entrepreneur as well as their own ability to source and evaluate.”(Amis & Stevenson, 2001, p. 190) This structure is the most simple and doesn’t take much time or other risks. The preferred convertible is the most commonly used structure. Investopedia defines Convertible Preferred Stock, “Convertible preferred stock is preferred stock that includes an option for the holder to convert the preferred shares into a fixed number of common shares, usually any time after a predetermined date (Convertible Preferred Stock, 2015).” With preferred stock it is not as simple as common stock and involves: information rights, board rights, anti-dilution, redemption rights, pre-emptive rights, and tag- along rights. Preferred might also include, liquidation preference, and dividend requirements. A quote from the Winning Angels book “The rule is that you use preferred to attract capital and you use common to attract staff.”(Amis & Stevenson, 2001, p. 189) The third fundamental structure is a convertible note which has become more popular due to it taking less time because of not involving negotiations, option pricing issues are limited because the price of common stock doesn’t change, and it secures liquidation preference.
Three simple rules to follow in the planning structure would be:

  1. Keep it simple
  2. Don’t restrict the company’s ability to do future deals
  3. Make sure the valuation is reasonable

What venture capitalists look for in deals that are already backed by angels?:

  1. Valuation
  2. Efficient corporate action
  3. Simplicity
  4. Board of Directors
  5. Compensation
  6. Founder Stock

Most investors consider different perspectives and use the structure accordingly, they try to give the entrepreneur control of the venture. Investors use debt to tie the entrepreneur to the project by influencing them to put up capital they don’t have. Other investors just accept the structure and rely on the entrepreneur and don’t worry about the deal terms. What winner’s do different is:

  • Keep it simple
  • Align interests
  • Get cash early whenever possible
  • Focus on the entrepreneur during evaluation
  • Get pre-emptive rights
  • Leave it to the lead
  • Limit conflicts

Winning tools and tactics that they use include writing out a one-page describing the deal. This should include: capital structure, involvement of the investor, expected time for entrepreneur to stay in business, salary level for entrepreneur, and reporting mechanism. The other tactic used by winners is building reporting into the deal this would include a monthly report that the entrepreneur builds to keep the investor updated of any changes.

 

References:

 

  1. Amis, David, and Howard H. Stevenson. “Structuring.” Winning Angels: The Seven Fundamentals of Early-stage Investing. London: Financial Times Prentice Hall, 2001. N. pag. Print.

 

  1. Staff, I. (2015, September 03). Convertible Preferred Stock. Retrieved June 13, 2017, from http://www.investopedia.com/terms/c/convertiblepreferredstock.asp
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