“Plain Vanilla” Angel Structure

It’s the middle of internet week!  I’ve already seen 30+ demos, in addition to Meetup Co-Founder Scott Heiferman smashing an iPad on stage at the tech meetup last night (which was at NYU’ Skirball center).  One theme that has been recurrent is that people are unaware of the structure of angel investments.  So, I thought I’d give a brief overview of one common structure.  Please note there is an excel file you can download at the bottom of the post.  It includes detailed notes and may be helpful to have open as you go through the post.

Many seed stage internet businesses look to angels to help them kickstart their companies through growth capital, as well as expertise.  It seems that many people are confused as to what a typical angel investment might “cost” them in equity.  And, while “a convertible note with a 10% PIK and a 25% discount to the series A” (also known as the “plain vanilla” angel structure) may make sense to some people, I thought I’d break down how to interpret that in case there were any non finance geeks out there who were trying to understand what the terms of an angel investment actually mean.

The Basics

I think it’s easiest to use an example to explain this type of investment.  So, Joe is the founder of Newco which is a website that does some sort of location/game based virtual good (insert other buzz words) service.  Joe needs to raise $500,000 to hire a few developers and a sales person.  Joe finds an angel investor who just happens to have a lot of experience in location/game based virtual good services.  Joe’s investor, let’s call her Ms. Jenna, gives him $500,000 and they use the plain vanilla (read typical) angel structure.

Instead of putting a value on the company now, the investor, will get equity based off of the valuation used in Joe’s Series A round of financing (more on that later).  Presumably, when Joe raises his Series A, he will have a few customers, some revenues, and a much better picture for how his company will actually operate.  His company will therefore be more easily valued.


PIK stands for paid in kind.  Ms. Jenna is putting up $500,000, and expects Joe to pay her 10% in interest each year.  But, Joe doesn’t have any cash as he is a pre-revenue startup.  So, instead of paying in cash, Joe is going to take the value of the dollars he would pay Ms. Jenna, and add that to the principal of the investment.

In our example, in the first year, Joe will take the 10% interest payment (worth $500,000 x 10% = $50,000) and add that to the principal of the investment, which will now be $500,000 + $50,000 = $550,000.  In the next year, Joe will be charged 10% on that new principal.  His new interest payment is $550,000 x 10% = $55,000.  And his new principal amount is $550,000 + $55,000 = $605,000.  For those familiar, this is the same concept as a negatively amortizing loan.  Instead of paying interest in cash, it is paid as principal, which is the same as saying it is paid in kind (PIK).

The Equity Part of the Equation

We are going to pretend that Joe had a rough go of it and doesn’t raise his series A for 5 years.  In year 5, the principal value of Ms. Jenna’s investment is now $805,225 (please see attached excel to see the calculations, rows 19 and 20 – we just added the 10% interest in each of the 5 years).  The series A investor gives Joe $1 million dollars at a $4 million post-money valuation meaning that they will get $1 mm/$4 mm = 25% of Newco’s equity.  For the difference in pre vs post money valuations, please see the attached excel cell C14.

We said that the angel investment would be invested at a 25% discount to the series A.  This means that instead of investing at a $4 million valuation, Ms. Jenna’s dollars get put to work at a $4,000,000 x (1-25%) = $3 million valuation.  And, her $500,000 originally invested has grown to $805,225 due to the interest which has been paid in kind.  So, her ownership in the company will be $805,225/$3,000,000 = 27%.

At the risk of complicating things, it is worth noting that Ms. Jenna’s original angel investment can also come with a valuation cap, meaning that there is a maximum value that her dollars can be put to work at.  In the excel, I have put this at $10,000,000 so it doesn’t come into play.  But, if Joe’s company was worth $20,000,000 in 5 years when he raised his series A, Ms. Jenna’s equity would be calculated using a valuation of $10,000,000, not the typical 25% discount we have used in our example.  You can see how this benefits the angel investor in the case that they company does take off.  Ms. Jenna will invest her money at a $10,000,000 valuation as opposed to a $ 15,000,000 valuation ($20,000,000 x (1-25%) = $15,000,000)  which would give her a larger equity stake in the company.

End Result

Joe has now raised $1.5 million and is hopefully well on his way to a successful career at the helm of Newco.  He has given up 25% to his series A investors, and 27% to his angel investor Ms. Jenna, and so retains 48% for himself and the rest of his team.

The attached excel sheet has all of these calculations and is set up in a way that you can play around with different assumptions.  Please feel free to email me with any questions! phil (at) philstrazzulla (dot) com.  Also, please note that this is meant to be an overview of one type of common angel structure and that there are definitely more out there.   Enjoy!

The Excel: Angel Investing Basics

Some Thoughts on Pricing Models for Lead Gen. Busineses PT. 2

Last time I wrote about lead generation and some thoughts on how to price leads.  Now, I’d like to walk through an example of how to get to a starting price.  I’ll lay out some of the basic math, some of the finer points that have to be considered on a case by case basis, and what I consider to be the best way to get the data necessary for this type of analysis in a nascent and undefined market where secondary sources are lacking.

Example: Company A is the buyer of leads, Company X is the seller of leads (aka the lead gen company).

Company A makes 1,000 outbound calls to get 100 leads, which converts to 30 appointments, which converts to 5 sales with an average selling point of $10,000.  So, for those 1,000 outbound calls, Company A grosses $50,000 (these numbers are totally fictitious by the way).

Company X’s leads are “more qualified” because people opt-into them only when looking to make a purchase decision.  Therefore, 90% turn into appointments.  Every 100 qualified leads => 90 appointments => 15 sales = >$150,000 in new revenue.

This is where things get tricky.  We know how much revenue our leads are potentially worth.  But what does this translate to in terms of what they are worth to Company A (taking into account the extra FTEs freed up that don’t have to spend their time prospecting)?  Let’s assume that the internal sales person makes 20 prospecting calls in an hour and their time is worth $25/hr.  Our 100 leads convert to 90 appointments which would be the result of 3,000 outbound calls (3,000 calls=>300 leads => 90 appointments).  These calls cost Company A (3,000/20)*25=$3,750, or $37.50 per qualified lead.  Of course, this number doesn’t include a whole lot of other factors that could get in the way, but you get the idea (we could also factor in the lower cost of converting Company X leads in appointments even from the “lead” part of the funnel since they require fewer conversations given the higher lead => appointment conversion rate, and thus less time.  But, let’s keep this simple).

These numbers are good starting points in getting a picture of how much to charge per lead.  Basically, we want to get a sense for where our leads fit into the customer’s pipeline, and how much it would cost Company A to get the same quality of lead without us.  That’s what it’s all about!

These are just preliminary thoughts.  But how to get this data?  My advice would be to join the relevant LinkedIn groups for salespeople in your industry, and cold email them.  Why are sales people in this industry giving you accurate information (or even talking to you in the first place)?  Because you are an entrepreneur, they are intrigued enough at the prospect of talking to a potential employer, and are therefore willing to ingratiate themselves through providing (hopefully) insightful and accurate data around their sales efforts.  Plus, salespeople just like to talk.

Here are some questions I’d ask the people you get a chance to speak to: the all in costs of each sales person (base + bonus + benefits.  If you’re going to be replacing FTEs with your leads, then you need to know the ROI you’re providing Company A); what the sales cycle is (how long does it take, what is the overall process), and where your leads will fit into this equation; whether you’d have the same appointment to sale conversion rate on qualified leads as on prospected ones (qualified leads are actively searching and therefore will be evaluating your competitors whereas cold sourced leads may not be, but cold sourced leads may not really be in the market for the product); the organizational challenges of managing a large sales force; the ability your leads may offer for Company A to specialize its sales force (i.e make some people dedicated closers, and others focused on prospecting, or get rid of prospecting all together which may raise morale and increase efficacy).  There are, of course, many more relevant questions.  But, hopefully this list would provide a solid starting ground.  Remember, the bottom line is figuring out where your leads fit in and why, how much value they are offering your client, and starting from there.

Each industry has their own idiosyncrasies, and you have to keep in mind why your pricing makes sense versus your “competition” (internal sales teams in our example, but quite easily other lead gen companies or outsourced sales resources).  Are you going to under price and offer an ROI analysis for potential buyers of your leads?  Are you going to replace an existing lead service that offers unqualified leads at a discounted price?  Will these be exclusive leads?  All very interesting questions!

If you have any feedback on any of my posts or just want to say hello, please email me: phil (at) philstrazzulla (dot) com.

Some Thoughts on Pricing Models for Lead Gen. Busineses PT. 1

The other day I had a very interesting conversation with an entrepreneur who is about to launch what is essentially a lead generation business in a nascent but well defined vertical (which will remain unnamed for now).  We were talking about his revenue model, which is still very much in the works, and also some initial thoughts on how to price his leads which I thought would be interesting to share.

For the uninitiated, lead generation businesses develop potential sources of new business and sell these sources to companies interested in reaching these sources of business.  An easily understood example is that of financial planning lead generation.  There are many websites that capture data on people looking for advice on Annuities, ETFs, etc.  The companies that capture this data then sell it to financial planners as qualified leads.  The process looks a little something like this:

These leads then find their way into the sales funnel of the buyer of the leads. Below is an example of what a typical sales funnel for a financial planner may look like (the leads that we would collect as a third party lead generator would fit in somewhere between leads and appointments, more on that later):

If you’re providing leads into this funnel as a third party, it’s important to track the efficacy of your specific leads throughout this funnel.  In fact, many lead generation companies do not get paid per lead, but rather based on the number of appointments their leads can generate which is a proxy for how well qualified the leads are.

Now, about the actual pricing of the solution.  I’d like to shift away from financial services for the time being as that market is fairly well defined.  The competition you’d face within financial services is other lead generation companies (as this is a mature market as far as lead gen goes) and therefore the price is set at the market rate unless you can offer a differentiated product.

Shifting towards my entrepreneur friend’s nascent market – there are no other lead gen businesses, nor is there any outsourced sales organizations servicing this vertical.  Therefore, the focus is on competing with internal sales forces.  Understanding the compensation structure was the most important take away that I could offer.  Most internal sales reps, especially those selling big ticket items, are paid a minimal base salary and large performance based bonuses.  The key is to figure out where your leads fit into their sales pipeline, and then figure out the expected value of that lead to the company, as well as the expected cost associated with that lead if it were brought in through the internal sales team through telesales, direct mail, etc.  As this post is getting a bit long and Lost is on tonight, I’ll leave walking through an example with some numbers until part 2.

PHP MySQL Workshop at Hive 55

This evening I attended the PHP MySQL workshop at Hive 55, which is one of the growing number of shared workspaces in New York City.  For the unfamiliar, shared workspaces are locations where people from many different walks of life choose to work for anywhere from 1 to 30 days per month.  It’s a great way to network, meet people with complimentary skill sets, and avoid the temptations inherent in working from home.  These types of initiatives will no doubt catalyze the growth in Silicon Alley that everyone keeps talking about.

Plus, they host cool events like tonight’s PHP/MySQL workshop which covered some of the tools used to build basic dynamic web pages.  Tonight’s lecture was given by Hans from http://www.bootup.io/.  I think we were all a bit shy at first, but the discussion got very interactive and there was some great networking afterwards.  I was lucky enough to meet Ryan Clarke and Dave Tomback who shared some of the challenges they are currently facing in building their respective startups.  The underlying theme was that business people like us need a technologist co-founder, especially if you’re thinking of outsourcing development.  Easier said than done in NYC, but good advice nonetheless.

As far as PHP tutorials, I’d also like to recommend the PHP Academy page on Youtube.  These videos are short, sweet and very useful.  Alex is one of the very best developers that I’ve come across when it comes to being able to explain concepts in an easily understandable manner.  I was even more impressed to find out how young he is.

Also, if you’re wondering how I found out about tonight’s event – I receive the NYC Edition of the weekly Startup Digest.  If you live in NYC and have any interest in attending tech related meetups, job fairs, etc, I highly recommend signing up for this newsletter.  They have editions for about 25 other cities, so check them out.  Enjoy!

Hello World

There is always a bit of awkwardness in a first interaction, so I will break the ice with an introduction.  My name is Phil.  I am 24, live in New York City, and work in finance which I was trained to do at the illustrious Stern school of business at NYU.  Beyond any formal training, finance, business, and the confluence of the two are subjects I’ve been interested in for quite some time now.

I recently built a site: www.wrestlingontv.com.  I was (and still am) a huge fan of amateur wrestling, but find it very hard to track when the world’s oldest (as in first sport in almost every culture known to man) and greatest sport will be on TV, or even streaming on the internet.  I’m guessing the same problem goes for a lot of fans of non revenue, tertiary sports.  So, I am trying to develop a scalable model to track all of the wonderful coverage that my sport deserves and make it easy for others to know when they can enjoy this coverage.

I started with close zero technical ability (unless you count building really long formulas in excel, or that one week in 8th grade I spent learning BASIC in the hills of Western Massachusetts).  Therefore, I thought it would be helpful to document some of the resources I used to learn a bit of PHP, Drupal, MySQL, etc.  Also, I have a much more ambitious and involved project which will hopefully develop over the next several weeks and months which will be a lot of fun to write about.

While I’m keeping the newer project a bit of a secret for now (something most VCs would probably frown upon and call me paranoid for), I think that a lot of what I’m learning about SEO, databases, etc will be worthwhile to post.

I also am excited to write about my thoughts on the economics behind everything from Night Life to Brooklyn Kickball.  Please stay tuned, and send me an email if you are so inclined.