By Fernando Berrocal
Angel investors are wealthy, private investors who specifically fund startups–in return for equity. Angels solely utilize their net worth when investing, which strikes a contrast to venture capitalists (VCs), who provide capital through an investment fund. Angel investors tend to also be more flexible with entrepreneurs, and are willing to make smaller financial commitments over a longer time. Clearly, finding such an investor is a huge advantage for startups; however, structuring the right agreement with angel investors is crucial to the overall success of the partnership.
To attract potential investors in the first place, entrepreneurs must learn how to structure angel investment arrangements. As a startup founder, you must familiarize with the fundamentals of due diligence, have confidence in negotiating conditions, and learn how to complete deals. Angel investment agreements should be structured in a way that benefits both sides of the table. With the appropriate, well-thought-out agreement in place, both parties will profit. This stage of a startup’s journey - the first deal with an angel investor - is crucial since all the conditions that you accept here will eventually apply for the duration of the angel investment agreement.
How to Structure an Angel Investment Deal
If you have decided to fund your startup through an angel investor, crafting the proper agreement with this individual is critical to the future of your business. The basic methodology can be broken down into six principles:
- Select the most beneficial type of angel investment for your business.
Be aware that there are primarily two kinds of seed-stage angel investments in this situation. You choose how much stock each investor receives in exchange for their investment. How you decide how much equity to invest is the difference. The main types of angel investments are:
- Equity Share: An agreement to an ownership stake in your business.
- Convertible Note: A convertible note entails that you and your partner will consent to an early valuation of your property based on a few factors.
- Consult a lawyer about the details of your agreement.
At this stage, entrepreneurs become so enthusiastic that they overlook doing their paperwork correctly. Before agreeing to any contract with an angel investor, speak with a specialized lawyer to better understand the terms and structure of the deal. Make sure to provide your attorney with all relevant materials regarding the potential agreement.
- Negotiate equity.
An investor will exchange his funds for an equity part in your business. Depending on the value that both you and the angel investor agree on, the investor will receive a certain amount of equity. For example, if the investor invested $175,000 in cash and your business was worth a million dollars, they would earn 17.5 percent of the startup. From this point, things may get extremely difficult to get into account.
You can issue a variety of stock, such as fast-paying or voting-rights-equipped shares. The majority of business transactions will be structured as an equity stake for cash. Remember, speaking with a specialized lawyer during these tense discussions can be very beneficial for both parties. The implications of these clauses can be complicated to comprehend for the decision-makers on both sides.
- Purchase convertible loans with cash or equity.
Entrepreneurs and investors may not always agree on how much a business is worth at present. When situations like this arise, businesses could elect to issue convertible bonds. These bonds provide both parties the option to decide how much the business is worth in the foreseeable future. This typically occurs when additional outside funding is involved. A debt to a business known as a convertible note matures when an investor contributes $150,000. Imagine it takes a year to eventually mature. Over that period, interest will probably accumulate. The investor has two choices at maturity: one is to request cash payback; this is similar to an unsecured loan. The other is to turn the funds into equity. These are based on the value of time.
Convertible notes have become more popular among business owners and angel investors over time. It enables both parties to cooperate to maximize their investment. The investment will become a modest equity stake if the business does extraordinarily well and raises professional capital rounds at a high valuation within a year. The chance for investors to profit from this transaction remains open. It indicates that it has worth at the very least. The market worth of the business may be less than what the investor received when they made their investment if the organization is bankrupt. For the same amount of money invested, they would receive greater equity. This does not necessarily represent a good offer, since it lowers the firm's worth.
- Produce a term sheet.
All terms and conditions of investments are described in documents known as term sheets. Therefore, you will either give or receive a term sheet from the investor once you have decided on the size and form of your business investment. Remember that a term sheet is required for every pitch you make. Although it doesn't necessarily imply that you have money in a bank account, this does show that the investor is interested in making a transaction.
- Remember: Once a deal is closed, it is not finalized.
A term sheet does not indicate that the closing legal paperwork is completed. Even if everything is done correctly, the entire process can take up to 2 or 3 months. In some instances, it can take even longer than the typical 90 business days. If it takes more than 120 days, it can be a failure. So, keep your guard up when you see a term sheet. It's simply an expression of genuine curiosity. Once you have the check in your bank, you can celebrate.
Ready to bring your startup to the next level? Apply to MassLight’s next batch. MassLight supplies capital and a dedicated tech team. We take equity in return. Have questions? Refer to our FAQ page.
%C2%A0Marketing%20Strategy.jpg)
