Angel Investment
For individual investors to invest in early stage startups
What is Angel Investing?
Angel investors (or “Angels”) refer to individuals who offer funding in exchange for a future (or immediate) equity in a promising startup. Angels often invest during the early stage of a startup’s fundraising cycle, when the startup exists only as an idea or prototype. Angels can invest alone or pool investments with other angels, forming a “syndicate.” Most angels invest between $5,000 to $150,000 in companies valued between $1m to $4m.
What is the angel investment process?
Here are the standard steps of an angel round of startup fund raising:
Step one - Establish and Screen Deal Flow
Angels connect with young startups via word of mouth, referrals, or professional investment networks such as accelerators and pitch contests.
Step two - Due Diligence
After confirming interest, angels conduct due diligence on the startup’s founding team, review the business’s pitch deck, business plan, disclosure documents, as well as doing research on the startup’s industry and growth trajectory.
Step three - Negotiate and Sign Deal Documents
An attorney drafts up and negotiate a term sheet with details of the investment terms, payouts, equity, rights and protections, governance and control rights, exit and liquidity planning, and other bells and whistles designed to anticipate a successful exit and other scenarios.
Step four - Deal Close
Once the investment contract is signed, fund is released into the startup’s account and the deal is officially closed.
What are the common types of investment instruments?
There are four most common types of equity and debt instruments used in startup financings:
Convertible Notes
What it is. A convertible note is a debt instrument with a feature to automatically convert into equity upon certain triggering events - most commonly an upcoming series A preferred stock financing. Convertible Notes combine the safety of debt with a greater potential upside once converted.
Maturity date and interest rate. Like a traditional loan, a convertible note has a maturity date by which it is supposed to be paid back, and an interest rate, generally ranging from 2% to 8%. If a Convertible Note is not paid back past the maturity date, note-holders can sue the company and demand the repayment of their debt.
Conversion discount. Convertible notes commonly have a discount between 10% to 20%.
SAFEs
What it is. SAFE stands for “Simple Agreement for Future Equity” and is popularized by Y-Combinator. SAFEs are simpler than convertible notes, is much more startup friendly, but less investor friendly.
No Maturity Date no interest rate. SAFEs are not debt instruments, therefore have no maturity date or interest rate. SAFEs provide contractual rights of repayment in cases of bankruptcy that are on par of common stock holders. Though these scenarios have not been fleshed out in court.
For a discussion on the pros and cons of SAFE vs Convertible Notes, see our article here.
Preferred Stock and Common Stock
It is rare to see preferred or common stock deals compared to SAFE or convertible note deals. In these cases, investors will take straight up stocks from the company, as opposed to a note or a promise to issue stocks. This will make the fund-raising an “equity round” where the startups will need to come up with a valuation. Due to the complexity of valuation and the requirements needed for an equity round, these two types of deals are much more expensive.
What documents should I expect to sign?
Term sheet
Investor Questionnaire
Convertible Note or SAFE