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Angel seed investing

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Angel   seed investing Angel seed investing Presentation Transcript

  • Angel/Seed Investments Andrew Thornborrow – BlueRun Ventures February 17, 2011
    • Why Seed? - Supply
    • Product Build – Consumer internet / mobile startup costs have decreased substantially (Open Source, Cloud-based, Short development cycle).
    • Customer Acquisition – Enormous distribution channels via search (Google), social (Facebook / Twitter) and mobile (iPhone / Android) platforms.
    • Result – Tons of new companies being formed. $500K goes a loooong way (at least initially).
    • Why Seed? - Demand
    • Incubators / Accelerators
      • Y Combinator
      • DogPatch
      • Founder Institute
      • TechStars
      • AngelPad
      • SSE Labs (Stanford)
      • NYC Seed
      • DreamIT Ventures (Philly)
      • First Growth Venture Network (NYC)
    • Individual Angels – AngelList
    • Super Angels / Seed Investors
      • Floodgate (Mike Maples)
      • Felicis Ventures (Aydin Senkut)
      • 500 Startups (Dave McClure)
      • SofTech VC (Jeff Clavier)
      • SV Angel (Ron Conway)
      • Harrison Metal (Michael Dearing)
      • Lowercase Capital (Chris Sacca)
      • First Round Capital
      • Betaworks
      • Founder Collective
    • Structures
    • Convertible Notes
    • Series A Light (Series 1, AA, Seed, A’)
    • Traditional Series A
    • “ Convertible notes have won. Every investment so far in this YC batch (and there have been a lot) has been done on a convertible note.”
    • - Paul Graham (Y Combinator), August 2010
    • “ I have been doing venture capital for 25 years now and have also done many angel investments personally along with my wife. We have never done a convertible debt round…. I don't like convertible debt for a host of reasons. It used to be that convertible debt was a lot easier and cheaper to do legally. But with non-negotiated ‘light series A docs’ from most top venture law firms out there, you can do a Series A Preferred for less than $5000…. I am a sophisticated investor. I do this for a living. I can negotiate a fair price with an entrepreneur in five minutes and have done that for a seed/angel round many times.”
    • - Fred Wilson (Union Square Ventures), August 2010
    • “ Have convertible notes really won?  And if so is that good for start-ups? Good for investors? I think the answers to these questions are that 1) it’s not at all clear that this trend is as definitive as Graham suggests; 2) it’s a mixed bag for entrepreneurs (more positive in the short run, potentially negative in the long term); and 3) it’s clearly not a positive trend for early-stage investors.”
    • - Seth Levine (Foundry Group), August 2010
    • “ Best for seed is convert w/ cap (*need* cap). Gives investors economic rights but not control rights and keeps legal fees down.” “The only advantage of equity over convert w/ cap is investor control, which you don't want/need. Let great people do their thing.”
    • - Chris Dixon (Hunch; Founder Collective), August 2010
    • Convertible Notes
    • Amount - $50k-$750k
    • Discounts and valuation caps (converts at lower of X% discount or $Y million valuation – valuation cap may increase for subsequent closings); Warrant coverage
    • Discount shares as common vs. preferred (liq pref kicker)
    • Automatic vs. Optional conversion (w/ majority control)
    • Seniority (no reference vs. senior to all future / no borrowing w/out lender consent)
    • Maturity – X date vs. closing of next round
    • If M&A prior to maturity/conversion, repayment multiple (2x-5x) or conversion to common at valuation cap
    • Participation right for next round (dollar denominated vs. right to get to X% post vs. other)
    • Interest – 0% to X%
    • Side Letters – observer rights, inspection / info rights, etc.
    • Protections against getting squeezed out of rights offered to lead investor in next round (e.g., “Major Investor” definition as tool to deprive noteholders of certain rights following conversion)
    • How option pool refresh is treated when calculating the valuation cap at time of next round (part of pre-money or post-money)
    • Series A Light - Just what it sounds like:
      • No Reg rights
      • No ROFR/Co-Sale rights (instead, no transfers w/out consent or assignment to investors of Company ROFR)
      • No Anti-dilution protection
      • Limited protective provisions
      • Minimal reps and warranties
      • No legal opinion
    • So What’s Better?
    • Depends (mostly on where you sit)…
    • Convertible Note :
      • Allows founder to build valuation / Avoid dilution so not upside down post seed financing, which arguably is bad for founder and future investors alike (valuation caps give investors protection).
      • Allows founder to delay control issues, which arguably don’t matter to investors at this stage but which are of much discussion currently among entrepreneurs.
      • “ Q: What’s the biggest mistake entrepreneurs make when they’re raising money? Entrepreneurs focus on valuation when they should be focusing on controlling the company through board control and limited protective provisions . Valuation is temporary, control is forever. For example, the valuation of your company is irrelevant if the board terminates you and you lose your unvested stock.” – Venture Hacks
      • Relatively less painful to get deal done – minimize back and forth / legal fees – so founders can spend more time on building the product.
      • Allows founder to work with an investor without being “married” to that investor.
      • Allows VCs to deploy capital quickly across a number of companies that they can spend time getting to know / developing relationship without Board/fiduciary obligations, etc.
    • BUT,
    • Founder’s/Buyer’s Remorse
      • Valuation caps that result in excessive discounts + liq pref kickers if discount shares are preferred -> bad for founder and new investors alike. Does discount go in pre-money? Should discount shares be common instead of preferred?
      • Lead investor in new round must decide whether should try to modify seed terms.
        • Result: 3-way negotiation (or 23-way negotiation if lots of seed investors) between founder – seed investor(s) – lead investor.
    • Signaling Issue – If seeded by VC, what if VC noteholder doesn’t follow?
      • Fix – Have more than 1 VC invest? What will the dynamics be post-closing? Will they work together or against each other?
    • Is Series A Light the Answer?
      • Convertible note structure can be more complicated than Series A Light given the extensive convertible note menu of items and interplay among them.
      • Convertible note with a valuation cap smells a lot like a priced round.
      • There is value to a founder (and early-stage investor) in locking in founder-friendly terms now (1x no participation, good vesting/acceleration, near-term/complete Board control, etc.) and then holding the line against new investors going forward.
    • BUT,
    • Extremely competitive environment and many angels / super angels have adopted the convertible note structure (at least for now).
    • Founders increasingly focused on control (super voting rights, Board control, etc.), especially given lower-dollar M&A valuations and (mis?)perception that there will be misalignment between founders and VCs re acceptable exit values.
    • No agreement on what are essential Series A Light terms -> multiple forms of Series A Light docs:
      • TechStars Model Seed Funding Docs (Cooley)
      • Y Combinator Series AA Equity Financing Docs (WSGR)
      • Founders Institute Plain Preferred Term Sheet (WSGR)
      • Series Seed Financing Docs (Fenwick)
      • Other law firm form docs stripped down
    • Series A Light docs may not shave meaningful time off the traditional Series A process given terms omitted are often not (heavily / at all) negotiated anyway. Given those terms will need to be added back in Series A, may actually be more practical to just add now (and do a Series A).