Angel Funding Framework

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  • <b>[Comment posted from</b> http://www.venturewoods.org/]
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  • <b>[Comment posted from</b> http://www.venturewoods.org/]
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  • It’s probably true that pure equity and debt financing in and of themselves don’t have all the desirable characteristics to get angel financing off the ground in a baseline risk-averse startup investing market like India. This scheme certainly attempts to combine the most desirable characteristics of both worlds and is an great initial step in the right direction.

    But if I understand it correctly, the intent of the above structure is to spur a scalable model of angel investing in India. When considered along with the implied subtext, the numbers as described above give investors disproportionately more leverage relative to entrepreneurs for entrepreneurs to get excited about this.

    If starting entirely from scratch (which may be a wrong assumption on my part), one year is hardly enough of a grace period to get a business to a point where using revenues to service debt payments would be a better capital allocation than reinvesting them in the growth of the business. In contrast, not only do investors get 25+% interest (annualized equivalent of 2% monthly compounding) but they also get five year-long preferred warrants--a disproportionately long horizon relative to the yearlong grace period the entrepreneur gets, which might even chill later-stage investor interest.

    For a scalable angel ecosystem to be created, angel investors need to realize that not all of their investments will return serviceable cashflows. Massive upside potential needs to be balanced by rationally proportional downside potential.

    Early stage businesses need capital, connections and domain knowledge--all three of them--to scale. If board seats and other value add aspects of the investor are seen as not core to preserving an investor’s investment interest, then this investor starts looking more like a banker or a growth equity shop that expects more or less predictable cashflows than a VC/angel who is on the same side of the table, genuinely interested in the upside.
    Just my 2 paise. Happy to chat more!-Vishy (vishy dot v at gmail)
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  • Cool !!
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Angel Funding Framework

  1. 1. Scalable Angel Funding Framework – Investment Structure<br />Objective: To provide an angel funding template for large scale financing of early stage businesses. These businesses might be good cash flow businesses, and many times, may lack the potential to scale into exitable companies in a short timeframe.<br /><ul><li>Desired CharacteristicsVCDebtPreference mechanism i.e. investor make returns before promoters doInvestor upside uncapped – equity style return potentialLow investment management overheadNo collateral from Entrepreneurs i.e. genuine risk capital to the businessAddress investor returns even in case of lack of liquidity or scaleGenuine risk financing – one in two business may fail</li></ul>Proposed framework:<br /><ul><li>Investor extends a certain amount (A) to the company as debt at [2]% monthly compounded interest, and a [1] year moratorium on payments. The interest rate may be varied based on risk perception and probability of the company to generate capital returns (see below).
  2. 2. After [1] year, the company must pay interest due monthly, and part principal, to the extent of at least [10]% of monthly revenue. It might pay more if it can at its discretion. For example, if the investment is 10 lakhs at 2% monthly interest (i.e. 20,000), and the business is making Rs 3 lakhs of revenue per month, it must repay Rs 30,000 a month (Rs 20,000 against interest and Rs 10,000 against principal to start with).
  3. 3. This debt will have typical debt covenants and charges on the business.
  4. 4. In addition, the Investor gets warrants to purchase an equivalent amount (A) worth of shares of the company, as per share price determined at a pre-agreed valuation level (B). The Investor is entitled to typical shareholder protection rights. The warrants are valid for next [5] years.
  5. 5. The board seat and other “value add” that the Investor could bring in can be individually negotiated, but are not necessary to protect basic investment interest of the Investor. Investors may also decide to selectively engage deeper with companies where they see more upside potential.</li></ul>Scenarios:<br /><ul><li>The company tries and fails to get off – Investor loses the debt investment since the company doesn’t have ability to pay. The warrants never get exercised since they are worthless.
  6. 6. The company builds some revenue base, but doesn’t break out – The investor gets interest and debt repayment. The warrants may be exercised, or not, depending on Investor choice – but will eventually expire if not exercised.
  7. 7. The company breaks out – The Investor makes a preferred return equivalent to the interest rate, and then can capture the upside by converting the warrants (and paying for that equity). The overall effect would be similar to a participating preferred structure in conventional venture termsheets.

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