Angel and Early-stage investments represent the highest returns of any asset class; however, they also represent a higher level of risk. If you are new to angel investing, the learning curve can be steep. There are steps that one can take to make early stage investment less risky and more rewarding.
As an angel investor, your funds are going into companies that typically have not proven their business model or, even when growing, they still face hurdles that are quite different and more challenging than those of established companies.
Seasoned investors are familiar with the funding journey, how to assess founding teams, and have learned to navigate negotiations that arrive at a good deal for investors and entrepreneurs.
Angel investment groups often include members with a broad range of investment and entrepreneurial backgrounds. As a result, investors who join angel groups can fill gaps in knowledge and experience. Most, like Keiretsu Forum, a national network of accredited investors, are well structured and offer high caliber peer networking—and in the case of Keiretsu Forum Mid-Atlantic and South-East there is an investor academy. The latter is a top level investor training program that accelerates an investor’s learning curve, building a solid foundation to fund startups and early stage high growth companies.
Most investors who join a group find they can better navigate through due diligence and complex term sheets with less stress and a better use of time. Notably, the collaboration among members yields an investment package that is viewed as a good deal for both investor and entrepreneur.
Whether you choose to do funding on your own or become a member of an angel group, there are costly “potholes” that every investor along the way wants to steer clear of:
Legally Binding Terms. Investors must fully understand the terms and conditions described in the term sheet and accept that they are entering into a legally binding agreement. The term sheet is just one of the deal documents, and most early-stage investors would do well to work with their attorney to ensure that the terms are acceptable and complete. To be clear – no matter what the entrepreneur tells you – ONLY the written terms have meaning and force in the agreement between the company and its investors.
First in Line. As an investor, you want to protect your share of the venture, looking to get your returns early and often. There are just three types of equity you can invest in; Common, Preferred, and Participating Preferred. Whenever possible, you want to ensure that you are first in line when a company issues distributions. For example, investing in a deal with Participating Preferred equity typically guarantees that you will get your investment back first and then participate ratably in the rest.
Protection in Future Rounds. You want to make sure future financing deals contain terms that do not unduly dilute your investment value or lead to someone moving into a superior liquidity position. For example, if I am to lead the investment round on behalf of an angel group, I want to lead the follow-on round so that we can protect as much of the position as possible. That allows all investors to co-mingle the rounds and offer equal protection to the investors in both fundings. A strong term sheet will pave the way for these kinds of protections.
Advisory. An investment package should protect against founder behavior that could damage the company. Significant investments may call for an investor Board seat combined with governance provisions requiring board or committee approval for a list of critical operational activities (or even in some cases reserving a veto right for the investor board member). If the investment level does not warrant an investor Board seat, it is essential to require that the company regularly share investors’ information on the company’s financial and business conditions.
Protect Your Right to a Return. As an investor, you want to maximize the chances of getting a return on your investment in all possible exit scenarios. Not all your investments will be home runs, and not all will outright fail. Adding a “Put Right” in the term sheet protects the right, typically after five years, to force the company to buy back the equity at the current value if they have not returned the original 1X investment.
As an investor, it is important to understand the details in a due diligence report and term sheet. To be clear – no matter what the entrepreneur tells you – ONLY the written terms have meaning and force in the agreement between the company and its investors. When angel group members collaborate on a deal, a more substantive in-depth diligence report results, fueling better decision-making that helps avoid investment potholes.
Read How One Angel Investor Group Attracts Top Investors, Yielding Great Deals
