I’m Loving Angels Instead
“Hey Ian, an angel investor has offered me £50k for 10% of the company and all he wants is a board seat. He has asked for my five year projections and then he’ll send across the money. Can you help me with that?”
I am paraphrasing from a conversation I had with a founder last quarter. It is not the only one. These dialogues between angel investors and founders happen frequently, sometimes with neither party clear on what a good outcome is. I have been on both sides of the table — I have made angel investments, am a member of angel syndicates and have advised founders in dozens of angel funding deals.
Angel investment outside the core tech centres is, in aggregate, value extracting. This is not by intention. It is purely an extension of a lack of successful company exits and hence few experienced angels helping set the standard on what good angel investing practices look like. This article is not a negative take on angel investment, rather the difference in approach between experienced and inexperienced angels when approaching a startup investment.
Founders you should know — there are some fantastic angel investors. Generally these people have exited a previous company or are long entrenched in the technology ecosystem with international exposure. They understand that the process of using private capital to fund a startup is a multi-stage game and not transactional. They add capital but also tremendous support, network and knowledge. These angels exist outside major tech ecosystems but there are fewer of them due to the paucity of significant exits in a region. Most angels in regional ecosystems have not had a high level of exposure to startup deals, markups on growth rounds and liquidation events. This information imbalance can cause early stage deals to be constructed in a way that is is disadvantageous to the outcome of the startup.
Let’s unpack the question at the start to try to understand who an angel investor is, how they behave and what a good deal looks like.
“Hey Ian, an **angel investor** has offered me **£50k for 10%** of the company and all **he** wants is a **board seat**. He just needs my **five year projections** and then he’ll send across the money. Can you help me with that?”
Who are angel investors?
Angels are different to venture capital investors. They are classed as either high net worth individuals or sophisticated investors. This means they have a considerable income, hold a lot of assets or have experience investing in the private markets as part of a firm or network. In reality, the bar is not as high as you would think. This means the spectrum of quality and experience is broad.
I have highlighted the word “he” in the question above. This was intentional as most of the angel investment community is male. There is a distinct lack of diversity that comes from a generation of technology enrichment being disproportionally allocated towards men. It is changing, although slowly. Diversity of investors is a real benefit to a founder — there are competitive advantages to looking outside your own geography, talking with other founders and angel groups who have greater access to diversified capital.
Locally, I have met some brilliant angel investors. These individuals understand that the founder is trying to create something and that their invested capital is a high stakes gamble on future outcomes. They don’t treat each investment as transactional and understand that it is merely the first money into a company helping them get to the next fundable milestone. You, as a founder, must understand this too. If you choose to raise capital you are on the treadmill and will use the angel investment to get to the proof points required to allow institutional capital to invest.
Experienced angels know that most of their investments will go to zero but that if they can invest in a broad range of early stage founders the likelihood is that one or two of those investments will more than pay for the rest. It is not a dissimilar mindset to early stage VC.
50k for 10%
This is when you begin to understand the difference between experienced and inexperienced angel investors. In my example, £50k is an enticing offer through the eyes of the entrepreneur. This is potentially enough money to quit their job and go all in. If required, they can hire a developer or agency to build out an iteration of the product. What’s the problem? Valuation.
Valuation is always an interesting negotiation. It is also the wrong thing to focus on. What matters is not how much the company is valued at but rather how much equity remains in the hands of the founding team after several funding rounds. It is not a one play game, it is multi-play with different people involved at different stages. By giving away too much at a very early stage the second order effect is that you put yourself in a position in 12–18 months time where you will struggle to raise the next round.
The current global median valuation for a pre-seed deal is between $5–8m so if you were to give away 10% of the company for £50k you are causing yourself problems you haven’t thought of yet. Inexperienced angels will tend to focus on valuation. Most angels have extensive business experience and are used to pushing for the best deal. It’s probably why they were able to accumulate wealth in the first place — they know how to negotiate. It’s just simply the wrong approach in an angel investment. Getting as much equity as you can for £50k is treating the investment more like a traditional financial instrument, calculating what the return on investment will be at a successful exit. It is counterproductive and often the investor learns this, but too late.
A more founder and company friendly deal would be for the angel to say that they will invest their £50k on a convertible loan note, SAFE or ASA. This means the angel sees the opportunity and is prepared to take a bet on you as a founder. Using one of these mechanisms lets the market price the round at a point in the future. Angels are aware that multiple rounds of capital will be required and their investment is to help you get to escape velocity. This is why some of the best angel investors are previous exited founders or employees of fast growing technology companies. They have muscle memory in what is required to build a company over time. To give these angels a reward for taking the early risk, you can offer discounts on the convertible loan but in line with what the venture market deems as reasonable. Remember, second order effects matter.
There is a kicker for UK Angel investors. They benefit from maybe the most generous tax incentives in the world on their startup investments. They can write off as much as 85% of the investment against tax if the business fails and, if the business is early enough, get a 50% write off in year one. This scheme is called SEIS and the positive is it has allowed for significantly more early stage capital to be invested into UK-based startups. The downside is that is attractive for all high net worth individuals so you are seeing some less experienced money move into the early stage market with well intentioned but negative effects. Overall, SEIS is a net positive but in my opinion it should be a bonus for investing, not the reason for doing it.
Five Year Projections
Due diligence on a deal is important for all parties. Founders get better by investors questioning them on their vision, hiring plans, market opportunity, product and financials. However at the very early stage the only things that matter are the market and the team. I have never seen an accurate five year financial forecast by any founder or investor. Entrepreneurs will, reasonably, get asked for this in later investment rounds as a test of their ability to forecast spending and revenue but at an early stage it is pointless. The founder is trying to go from 0 to 1, not 1 to n. If someone is asking for five year projections it is usually an indication they haven’t made a lot of early stage investments and as a founder you should be wary of investing too much time in something that is not valuable to the company.
Boards is a topic for a different piece but fundamentally you do not need or want a board at this stage of a company. As soon as there is institutional capital invested a board is a reasonable request and good practice to ensure proper corporate governance and coherent strategic planning. There are exceptions when a very early board is necessary and appropriate — for example, if you are working in a regulated space such as healthcare or financial services. IMPORTANT:- No board does not mean no responsibility to your shareholders. You should agree, as part of any investment, to supply all investors with monthly updates and they will be available to support you if you need help on company strategy and challenges. You do not need a board for this. Remember angel money is about going from 0 to 1. If an angel is asking for a board seat, or a board observer seat, you have not convinced them of your ability to execute and they see the board as the “management” of the company and their investment.
So, should I take angel investment?
Yes. Absolutely. If you are dealing with experienced angels it’s an easy decision. If they are less experienced, try to bring the investor along to the market understanding of what an angel can help the company do and that, if the company succeeds, they will be getting a 100 times return on that investment, not a 2 or 3 sized multiple. However this only happens if the funding rounds are structured properly, the company is well capitalised and the management team is trusted to execute.
In reality as soon as you decide to take on investment you should be plotting your path to Series A. Make sure the equity projections at an angel round make sense for the company. Remember an A round might be three investment rounds away — plan for dilution at each stage. If possible, use an ASA or SAFE note until you move to a priced pre-seed round. Experienced angels will understand and it will not put them off. New or inexperienced angels may not feel comfortable with these convertible instruments. That’s absolutely fine but you have to remember the second order consequences of taking that capital at a fixed price. It is only by more angel rounds in more startup companies that the local ecosystem builds the muscle memory to turn angel investing into a positive and accelerating force of the startup flywheel.
Thanks to those who helped me get the framing right on this, you know who you are.