The following is from
Ask The VC, where Brad Feld and Jason Mendelson of
Foundry Group answer questions related to venture capital investment and startups:
Q: I have an angel investor that is asking me for full
anti-dilution protection for the lifetime of their investment, along
with a host of other economic terms including dividends. They are
putting in a small amount of money, but are insisting that "this is the
way it is done." This doesn't seem right - am I missing something?
A:
(Brad) One of the challenges with angel (and VC) investors is that when
the macro-economy is tougher and money is harder to find, terms get
tougher. In many cases, especially with later stage companies, this is
completely appropriate. However, it's usually a mistake on the part of
the investors with early stage companies.
In our experience,
the simpler and more straightforward the terms in the angel round, the
better for all parties. The entrepreneurs raise much needed capital at
a fair price on terms that are easy to execute on. Equally
importantly, these terms shouldn't impede any future financings.
As
an early stage VC, I'm very comfortable investing in a company that has
previously raised angel money. However, I will always insist on
cleaning up any angel deal that was done poorly. "Full anti-dilution
protection forever" is an example of a term that should never exist.
Just because an angel investor bought 1% for an investment of $25k
(implying a $2.5m post-money valuation), that doesn't mean that angel
investor should have 1% of the company after another $10m has gone into
the company. While theoretically this is possible to negotiate away in
the next round, I've encountered angel investors who held up the
entrepreneurs and almost killed companies over irrational terms like
this, mostly just to demonstrate "how well they could negotiate."
Whatever.
Another silly example is the whole notion of
dividends in an early stage investment. Dividends occasionally get
paid out in VC-backed companies, but only when the companies become
solidly cash flow positive and have a huge surplus of cash. This is
such an atypical event that they early angel investors shouldn't be
worried about it. In addition, it's another term that will likely get
cleaned up in the next round, as the VCs will likely put generic
dividend language into the deal (e.g. "non-cumulative dividends of 8%
will be paid out only when declared by the board", which almost never
happens.)
My strong suggestion to all angel investors -
regardless of the macro-economic environment - is to "keep it simple
and fair." My recommendation to all entrepreneurs negotiating an angel
round is to make sure you have an experienced angel investor leading
the charge and helping you set terms.
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