If there is one thing I could take away from learning about the structure of a deal, if I ever were so fortunate to have an angel investor looking at my business, I would hire a lawyer. The variations of the structure are incredibly complex. Most investors will want what will give them a higher rate of return, which is convertible preferred stock. This option allows them to retain a fixed dividend at the beginning of the investment. When they see the capital start to rise and feel good about where it is going, they can convert to common stock. Converting their share to common stock allows them to realize profits from gains in the stock. An investor also takes on the risk of the stock’s declining value at that point, so hopefully, they see some indicators that make their decision to convert more certain. The preferred stock will mitigate the investor’s risk, but not allow for a high return on investment if it starts to gain momentum. Common stock provides limited risk for the entrepreneur. If the value of the company decreases, then so too does the investor’s equity. The investor would probably feel very strongly that a company is a winner if they agreed to common shares in exchange for their investment.
It is essential to get it right for the first time. Negotiation is one of Amis and Stevenson’s “Seven Fundamentals of Early Stage Investing,” but it seems clear that the deal would fall through without a consensus early in the process. The author state, “many angels think that negotiating to change the structure of the price is not a good start to their relationship with the entrepreneur (Pg 181).” An inexperienced entrepreneur would be wise to have an experienced attorney or accountant on their side to make sure they are getting the best deal possible.
“New firms with pioneering ideas and a flexible structure can often react to customers’ needs more appropriately than older, more established enterprises. (Tykvoka)” Although it is essential to have a structure in place that both the angel investor and entrepreneur can agree upon, both parties must possess a degree of flexibility. Ultimately it comes down to relationships as many things do in business. A trusting relationship between the entrepreneur and the angel investor will go a long way. If both parties recognize the idea is marketable and are motivated to make a deal, it will happen. Some investors are less concerned with the structure of the transaction than others. It takes a lot of time to review how the makeup of the deal. Keeping the agreement simple will help an investor to determine if investing in the entrepreneur’s company is worthwhile.
Similar to other aspects of early stage investing, there is no exact science to it. There are many variables based on the opinions of your investors, partners, advisory board members, and management staff. Faced with an angel investor’s decision as to whether or not to invest, I would keep my offer simple and consider the needs of the investor. Ultimately, it is the team and the idea that will guide their decision.
Amis, D. and Stevenson, H., (2001) Winning Angels the 7 fundamentals of early stage investing, Pearson Education Limited, ISBN 0 273 64916 7
Tykvoka, T. (2007), What do Economist tell us about Venture Capital Contracts?, Journal of Economic Surveys
Mitchell, C. (2019), Investopedia, https://www.investopedia.com/terms/c/convertiblepreferredstock.asp, Retrieved on 6/6/2020
Master of Entrepreneurship Website for Mike Weimar 