What's The Best Structure For A Pre-VC Investment?

Guest post by: Brad Feld
Become an Author

Free PDF Download
Deep Breath - By Brad Feld

I received the following question earlier this week. It’s conveniently timed, as I recently participated in two angel investments – each with one of the structures defined below.

What's the best/preferred structure of investment money pre-VC investment. We're in the beginnings of raising angel capital (~500k) and were wondering what, if any, considerations we should make regarding the investments to allow for VC later. Should we take convertible loans or issue straight preferred stock? What are the other options that are out there for investment structure? Is it too much of a hassle to handle future investments when there is an "angel group (say 5 doctors banded together)" versus a singular angel?

Assuming that you are planning on raising VC money some time in the future, there are two different typical structures for the first angel financing: (1) convertible debt and (2) preferred equity.

Convertible Debt: This is the easier approach of the two. In this case, the investment is in the form of a promissory note that converts into equity on the terms of a “qualified financing” (where qualified financing typically is defined by having a minimum amount – say $1m of total investment.) The note will either convert at a discount to the price of the qualified financing (usually in the 20% – 40% range), will have warrant coverage (usually in the 20% to 40% range), or both. This discount and/or warrant coverage gives the angel investors some additional ownership in exchange for taking the early risk. This note should be a real promissory note with the conversion and redemption characteristics clearly defined to protect both the investors and the entrepreneurs from any misunderstandings.

Preferred Equity: This is also known as a “light Series A” – it’s preferred stock that is similar to that a VC will get, but usually with lighter terms due to the relatively low valuation associated with it. For a very young company, a $500k investment can receive between 25% and 50% of the equity in the company and, as a result, many of the terms associated with a typical VC investment are overkill.

While either of these work, you’ll find some angels that strongly prefer one over the other. In addition, if you don’t believe you are going to raise additional VC money and will only be relying on additional small angel-type investments, the preferred equity approach is fairer to the investors as they’ll more clearly be participating in the upside on terms that are agreed to early in the life of the company.

Finally, I don’t think there is a difference between having “an angel group” vs. a single angel investor. However, you should try to insure that all of your investors are accredited and – if some aren’t – make sure you understand the implications of this.

Read this article in Brad's blog.

How To Raise Capital From Investors

For Good SEO You Must Go Back To Basics

Powerful Relationship Selling

What Type Of Start Up Business Financing Loans Are Available For A Canadian Company ? Startup Loan Info

What’s So Little About the Small Business Government Loan In Canada ! SBL Guaranteed Financing

Getting to your North Pole

The truth about those Foreclosures Short and Sweet

The Fundamentals of Raising Capital from Investors

Get The Lowest & Best Accounts Receivable Financing Loan Rates In Canada – Factoring Demystified!

Paying Royalties might be the best money spent in your Business

Canadian Franchise Finance Isn’t What You Think! Financing a Franchise Business Properly

Whats The Best Corporate Structure For An Early Stage Company

Are You Mastering Technology Financing ? Canadian Computer Leasing Must Know Info For PC Hardware And Other Tech Assets

The Benefits of a Structured Private Placement Offering

Three Years to Seven Figures

The Power Of The Government of the Canada small Business Financing Loan - SBL 101 !

The Gerber Method

5.1 Investment is vital for an economy to diversify: Economic Report on Africa 2007

Financial Analysis

Choose a Structure

Home > Entrepreneur-Advice > Brad Feld > Whats The Best Structure For A PreVC Investment > Google +

Free PDF Download
Deep Breath - By Brad Feld

About the Author: Brad Feld

RSS for Brad's articles - Visit Brad's website
Brad Feld is currently a Managing Director at Mobius Venture Capital and has been with the firm since 1996. Prior to Mobius, Brad founded Feld Technologies, which was sold to AmeriData Technologies in 1993, where he became Chief Technology Officer. Brad currently serves on the boards of a number of private companies, including Atreus, Comergent, ePartners, FeedBurner, Gold Systems, Judy's Book, Klocwork, NewsGator, Quova, Rally Software, and StillSecure. In addition, he is on the board of The National Center for Women & Information Technology, The Community Foundation Serving Boulder County, and The Colorado Conservation Trust. Brad has previously been a member of the board of directors of the Young Entrepreneurs Organization and founded the Boston and Colorado chapters. He holds Bachelor of Science and Master of Science degrees in Management Science from the Massachusetts Institute of Technology.
Click here to visit Brad's website.

More from Brad Feld
Managing Emotions Under Pressure
Getting My Attention
Why Do People Find Email So Difficult To Deal With
Rejection Not By You Really
How Many Angels is the Right Number

Share this article. Fund someone's dream.

Share this post and you'll help support entrepreneurs in Africa through our partnership with Kiva. Over $50,000 raised and counting - Please keep sharing! Learn more.

What's The Best Structure For A Pre-VC Investment?

Related Articles

Related Forum Posts

Share this article. Fund someone's dream.


Name:
Email: