ENT 640 Week 5 Blog: Structuring – by Mary Schuler

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As an angel investor, after valuing the opportunity and the deal has been considered, the next stage for angels is to discuss with the entrepreneur/owner about choosing deal structure and setting the terms.

Each angel may have different strategies when it comes to structuring deals. When you and the entrepreneur agreed on some basic terms, as a result it is time to determine and create a more detail term sheet. Many times the angel investor wants to be involved and hands on with the business, specific structure deal and terms that you want to bring win-win situations. If you can find an investor that has connections and advice from experience this may be a huge benefit for the company’s growth also. This stage should be clearly from the beginning because you will be carried this structure for the life of the deal. In some cases, “if you’re late in the process you have to accept the structure and terms that have been agreed to by others,” says Darryl Wash.

According to the authors Amis, D. and Stevenson, H. Winning Angels: The 7 Fundamentals of Early Stage Investing. Pearson Education Limited, 2001, there are three fundamental structures in angel investing:

  1. Common stock
    • With NO rights
    • With pre-emptive and tag-along rights

For example, if the deal is set up as an equity stake in exchange for cash, if the company is valued at $1,000,000 and you invest in $150,000 cash, it means you would get 15% ownership of the company. Like the authors said, this is the simplest structure and “used most by family, friends, and fools,” and “angels rely more on the integrity of the entrepreneur as well as their own ability to source and evaluate.”

  1. Preferred convertible with various terms:

The structure is not simple and “will require some significant interaction with the entrepreneur in the hoped-for event that additional capital is raised or an exit obtained.”

  1. Convertible note with various terms:

When the angel and the entrepreneur cannot agree on some valuation and others, they may opt to have a convertible note and it is setup as a loan to the company. This is used more popular as a tool for the investors.

For example, if the investor put in the company $150,000 as a convertible note, it would mature (come due) at a specific date in the future and will likely accrue interest. At the maturity date in the future, the investor can choose to either ask to be repaid back in cash (like a loan) or convert that money back into the company as equity based on a valuation determined at that time.

On each structure, there are some major considerations:

  • Exit impact
  • Relationship impact
  • Downside protection
  • Upside protection
  • Entrepreneur protection
  • Worst case scenarios
  • Best case scenarios
  • Notes and suggestions
  • …and anything else you can think of that you may want to consider.

By choosing either approach for investment, you are deciding how much equity you will get, plus preparing yourself to continue the future rounds if the deal is successful and on worst scenarios if the deal is fail.

Before determining which structure to choose, make sure you completely understand each deal structure and terms and if you feel comfortable and or already thoroughly reviewed with a lawyer, then you may start proposing that structure.

 

Resources:

Amis, D. and Stevenson, H. Winning Angels: The 7 Fundamentals of Early Stage Investing. Pearson Education Limited, 2001.

https://www.forbes.com/sites/allbusiness/2015/02/05/20-things-all-entrepreneurs-should-know-about-angel-investors/3/#708c470a1acb

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3 thoughts on “ENT 640 Week 5 Blog: Structuring – by Mary Schuler

  1. Mary,

    Deal structure all seems so easy on those TV shows! This chapter helped bring me back to reality a little. Back to a world where there are endless terms and possibilities for deal structure. I feel like this is an area that I should become more acquainted with since as entrepreneurs we will either be giving or receiving an investment at some point (aside from bootstrapping, of course).

    Great post!

    Austin

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  2. Mary, I totally agree with you about making sure you understand all pieces of the deal structure and feel comfortable with them. I believe having a excellent attorney to review the deal structure is crucial. I have a friend who does worldwide projects using angel investors. He has a U.S. attorney and a attorney living in the country that the deal takes place. These attorney’s work together making sure all i’s are dotted and t’s crossed.

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  3. Convertible notes seem dangerous to me. Using your example, you are definitely in for giving up $150,000 if no equity deal can be made. Depending on how well your business is doing at the time, it can hurt you to give up $150K or give up equity that may not be worth the $150K investment. It seems like it would be easy to get ripped off, but I would imagine most investors want to maintain their reputations and will negotiate a solid deal.

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