"Can’t we all just get along?"
— Rodney King
I was talking this afternoon with one of our CEO’s, Tim Stultz, at Imago. He mentioned that he had been cornered at a cocktail party by a number of local angel investors. They proceeded to lay into him about how evil venture capitalists were, how VC’s always screwed them and how could he work with VC’s. They said that they took the risk, helped start the businesses and ended up getting crammed down in the end.
Tim pushed back (guess we will have to do an upround next financing!) and said that the terms he had seen in some of their deals were unrealistic and screwy. My favorite, which he mentioned as well, is the non-dilution clause…the angel investor will maintain their % ownership even after the new money comes in.
I don’t think this kind of relationship has to develop like this. The biggest issue in these deals is that angels try and structure/price financings with no understanding or knowledge about what a likely next financing will look like. When reality hits and all of their bells & whistles are torn out, they feel violated. For example, on the non-dilution cause, who then takes the brunt of the dilution…management. Who does the new investor affiliate with…management (not the old investors). So, why set yourself up for a certain reversal that won’t stick.
The second issue is that angels pump all of their money into the deal day one (or a large portion). We have spoken a lot about this in the past. Dry powder is king. Angels aren’t the only ones hit hard when they run out of money. Every VC will also go along for the ride.
The third issue is set up by the entrepreneur. Sometimes they raise money from angels because that is their only source. However, a number of times, they do it because the angels will give them all of the terms the VC’s won’t. They get a high valuation which, when milestones are met, gets hammered by the new money coming in.
So, my greatest advice to angels is to use convertible debt. Don’t try and guess what the right structure is. Simply have a vanilla vehicle that converts into the next round and use warrants to get a discount. Some VC’s will push the money to common and some will try to strip the warrants off. However, most will let it fly. This eliminates many of the sticking points. Also, make certain that you preserve dry powder. Put 1/3 of your eventual total allocation in day one.
My advice to entrepreneurs is don’t stuff the angels with crappy terms. Realize that they are sticking their necks out for you so don’t start out with a deal at a $19m post-$ at the seed level unless you are a rock star.
Listen to the Oracle of the LA Riots and get along!