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Angel seed investing


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Published in: Economy & Finance, Business

Angel seed investing

  1. 1. Angel/Seed Investments Andrew Thornborrow – BlueRun Ventures February 17, 2011
  2. 2. <ul><li>Why Seed? - Supply </li></ul><ul><li>Product Build – Consumer internet / mobile startup costs have decreased substantially (Open Source, Cloud-based, Short development cycle). </li></ul><ul><li>Customer Acquisition – Enormous distribution channels via search (Google), social (Facebook / Twitter) and mobile (iPhone / Android) platforms. </li></ul><ul><li>Result – Tons of new companies being formed. $500K goes a loooong way (at least initially). </li></ul>
  3. 3. <ul><li>Why Seed? - Demand </li></ul><ul><li>Incubators / Accelerators </li></ul><ul><ul><li>Y Combinator </li></ul></ul><ul><ul><li>DogPatch </li></ul></ul><ul><ul><li>Founder Institute </li></ul></ul><ul><ul><li>TechStars </li></ul></ul><ul><ul><li>AngelPad </li></ul></ul><ul><ul><li>SSE Labs (Stanford) </li></ul></ul><ul><ul><li>NYC Seed </li></ul></ul><ul><ul><li>DreamIT Ventures (Philly) </li></ul></ul><ul><ul><li>First Growth Venture Network (NYC) </li></ul></ul><ul><li>Individual Angels – AngelList </li></ul><ul><li>Super Angels / Seed Investors </li></ul><ul><ul><li>Floodgate (Mike Maples) </li></ul></ul><ul><ul><li>Felicis Ventures (Aydin Senkut) </li></ul></ul><ul><ul><li>500 Startups (Dave McClure) </li></ul></ul><ul><ul><li>SofTech VC (Jeff Clavier) </li></ul></ul><ul><ul><li>SV Angel (Ron Conway) </li></ul></ul><ul><ul><li>Harrison Metal (Michael Dearing) </li></ul></ul><ul><ul><li>Lowercase Capital (Chris Sacca) </li></ul></ul><ul><ul><li>First Round Capital </li></ul></ul><ul><ul><li>Betaworks </li></ul></ul><ul><ul><li>Founder Collective </li></ul></ul>
  4. 4. <ul><li>Structures </li></ul><ul><li>Convertible Notes </li></ul><ul><li>Series A Light (Series 1, AA, Seed, A’) </li></ul><ul><li>Traditional Series A </li></ul>
  5. 5. <ul><li>“ 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.” </li></ul><ul><li>- Paul Graham (Y Combinator), August 2010 </li></ul><ul><li>“ 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.” </li></ul><ul><li>- Fred Wilson (Union Square Ventures), August 2010 </li></ul>
  6. 6. <ul><li>“ 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.” </li></ul><ul><li>- Seth Levine (Foundry Group), August 2010 </li></ul><ul><li>“ 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.” </li></ul><ul><li>- Chris Dixon (Hunch; Founder Collective), August 2010 </li></ul>
  7. 7. <ul><li>Convertible Notes </li></ul><ul><li>Amount - $50k-$750k </li></ul><ul><li>Discounts and valuation caps (converts at lower of X% discount or $Y million valuation – valuation cap may increase for subsequent closings); Warrant coverage </li></ul><ul><li>Discount shares as common vs. preferred (liq pref kicker) </li></ul><ul><li>Automatic vs. Optional conversion (w/ majority control) </li></ul><ul><li>Seniority (no reference vs. senior to all future / no borrowing w/out lender consent) </li></ul>
  8. 8. <ul><li>Maturity – X date vs. closing of next round </li></ul><ul><li>If M&A prior to maturity/conversion, repayment multiple (2x-5x) or conversion to common at valuation cap </li></ul><ul><li>Participation right for next round (dollar denominated vs. right to get to X% post vs. other) </li></ul><ul><li>Interest – 0% to X% </li></ul><ul><li>Side Letters – observer rights, inspection / info rights, etc. </li></ul>
  9. 9. <ul><li>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) </li></ul><ul><li>How option pool refresh is treated when calculating the valuation cap at time of next round (part of pre-money or post-money) </li></ul>
  10. 10. <ul><li>Series A Light - Just what it sounds like: </li></ul><ul><ul><li>No Reg rights </li></ul></ul><ul><ul><li>No ROFR/Co-Sale rights (instead, no transfers w/out consent or assignment to investors of Company ROFR) </li></ul></ul><ul><ul><li>No Anti-dilution protection </li></ul></ul><ul><ul><li>Limited protective provisions </li></ul></ul><ul><ul><li>Minimal reps and warranties </li></ul></ul><ul><ul><li>No legal opinion </li></ul></ul>
  11. 11. <ul><li>So What’s Better? </li></ul>
  12. 12. <ul><li>Depends (mostly on where you sit)… </li></ul><ul><li>Convertible Note : </li></ul><ul><ul><li>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). </li></ul></ul><ul><ul><li>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. </li></ul></ul><ul><ul><li>“ 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 </li></ul></ul>
  13. 13. <ul><ul><li>Relatively less painful to get deal done – minimize back and forth / legal fees – so founders can spend more time on building the product. </li></ul></ul><ul><ul><li>Allows founder to work with an investor without being “married” to that investor. </li></ul></ul><ul><ul><li>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. </li></ul></ul>
  14. 14. <ul><li>BUT, </li></ul><ul><li>Founder’s/Buyer’s Remorse </li></ul><ul><ul><li>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? </li></ul></ul><ul><ul><li>Lead investor in new round must decide whether should try to modify seed terms. </li></ul></ul><ul><ul><ul><li>Result: 3-way negotiation (or 23-way negotiation if lots of seed investors) between founder – seed investor(s) – lead investor. </li></ul></ul></ul>
  15. 15. <ul><li>Signaling Issue – If seeded by VC, what if VC noteholder doesn’t follow? </li></ul><ul><ul><li>Fix – Have more than 1 VC invest? What will the dynamics be post-closing? Will they work together or against each other? </li></ul></ul>
  16. 16. <ul><li>Is Series A Light the Answer? </li></ul><ul><ul><li>Convertible note structure can be more complicated than Series A Light given the extensive convertible note menu of items and interplay among them. </li></ul></ul><ul><ul><li>Convertible note with a valuation cap smells a lot like a priced round. </li></ul></ul><ul><ul><li>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. </li></ul></ul>
  17. 17. <ul><li>BUT, </li></ul><ul><li>Extremely competitive environment and many angels / super angels have adopted the convertible note structure (at least for now). </li></ul><ul><li>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. </li></ul><ul><li>No agreement on what are essential Series A Light terms -> multiple forms of Series A Light docs: </li></ul>
  18. 18. <ul><ul><li>TechStars Model Seed Funding Docs (Cooley) </li></ul></ul><ul><ul><li>Y Combinator Series AA Equity Financing Docs (WSGR) </li></ul></ul><ul><ul><li>Founders Institute Plain Preferred Term Sheet (WSGR) </li></ul></ul><ul><ul><li>Series Seed Financing Docs (Fenwick) </li></ul></ul><ul><ul><li>Other law firm form docs stripped down </li></ul></ul><ul><li>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). </li></ul>