Posted on by Phil

“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.

The PIK

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

7,477 Replies to ““Plain Vanilla” Angel Structure”

  4. It’s a shame you don’t have a donate button! I’d definitely
    donate to this outstanding blog! I guess for now i’ll settle for book-marking and adding your RSS feed to my Google account.

    I look forward to fresh updates and will share this blog with my
    Facebook group. Chat soon!

  8. Hey there would you mind letting me know which webhost you’re utilizing?
    I’ve loaded your blog in 3 completely different browsers and I must say this blog loads a
    lot faster then most. Can you suggest a good web hosting provider at a
    honest price? Thanks, I appreciate it!

  10. You’re so cool! I don’t suppose I’ve read through a single thing like
    this before. So wonderful to find another person with a few genuine thoughts on this topic.
    Really.. many thanks for starting this up. This website is one thing that’s
    needed on the internet, someone with some originality!

  11. Hello There. I found your blog using msn. This is a really well written article.
    I will make sure to bookmark it and return to read
    more of your useful info. Thanks for the post. I will
    certainly comeback.

  12. Do you mind if I quote a couple of your articles as long as I provide credit and
    sources back to your site? My blog is in the very same niche as yours and my visitors would genuinely benefit from some of the information you present here.
    Please let me know if this ok with you. Cheers!

  13. Having read this I believed it was rather enlightening.

    I appreciate you taking the time and effort to put this information together.

    I once again find myself spending way too much time both
    reading and posting comments. But so what, it was
    still worthwhile!

  17. Great post. I used to be checking continuously
    this weblog and I am inspired! Very helpful info specifically the
    remaining section 🙂 I care for such information much.
    I used to be seeking this certain info for a very
    lengthy time. Thanks and best of luck.

  18. Magnificent goods from you, man. I’ve understand your
    stuff previous to and you’re simply extremely magnificent. I really like
    what you’ve obtained here, really like what you are saying
    and the way in which you are saying it. You make it enjoyable and
    you still care for to keep it smart. I can’t wait to learn far
    more from you. That is actually a wonderful site.

  19. Hey there, I think your website might be having browser compatibility issues.
    When I look at your blog site in Firefox, it looks fine but when opening in Internet Explorer, it has some overlapping.
    I just wanted to give you a quick heads up! Other then that, wonderful blog!

  21. You really make it seem so easy with your presentation but I find this matter to be actually something that I think I would never understand.
    It seems too complex and very broad for me. I am looking forward for your next post, I’ll try to get the hang of it!

  23. Hello there, just became aware of your blog through Google, and found that it is really informative.
    I am gonna watch out for brussels. I’ll appreciate if you continue this in future.
    Lots of people will be benefited from your writing.
    Cheers!

  24. When I originally commented I clicked the “Notify me when new comments are added” checkbox and now each time
    a comment is added I get three e-mails with the
    same comment. Is there any way you can remove me from that service?
    Cheers!

  28. A person necessarily lend a hand to make seriously posts I’d state.
    This is the very first time I frequented your website page and to this point?
    I surprised with the analysis you made to make this particular
    post amazing. Great job!

  29. Magnificent goods from you, man. I have take note your stuff previous to
    and you are simply extremely fantastic. I really like what you have
    obtained right here, really like what you’re saying and the way by which you assert it.
    You make it enjoyable and you continue to take care of to stay it smart.

    I can not wait to learn much more from you.
    This is actually a wonderful site.

  30. Hey there! I know this is kind of off topic but I was
    wondering if you knew where I could find a captcha plugin for my comment form?
    I’m using the same blog platform as yours and I’m having problems finding one?
    Thanks a lot!

  33. Hello! This is my first visit to your blog! We are a group of volunteers and starting a new project in a community in the same niche.
    Your blog provided us beneficial information to
    work on. You have done a extraordinary job!

  34. Howdy! Do you know if they make any plugins to protect against hackers?

    I’m kinda paranoid about losing everything I’ve worked hard on. Any recommendations?

  36. I feel that is among the most important info for me. And i am satisfied reading your article.
    But wanna remark on some common things, The web site taste is great, the articles is really nice : D.

    Excellent activity, cheers

  40. Pretty portion of content. I simply stumbled upon your website and in accession capital
    to say that I acquire in fact loved account your blog posts.
    Anyway I’ll be subscribing in your augment or even I success you get right
    of entry to constantly fast.

  42. Hello it’s me, I am also visiting this site on a regular basis, this web page is truly nice and
    the viewers are actually sharing good thoughts.

  45. Hi, I do think this is a great site. I stumbledupon it 😉 I am going to come back once again since
    I book marked it. Money and freedom is the
    greatest way to change, may you be rich and continue to guide other people.

  47. I blog often and I seriously thank you for your information. This great
    article has really peaked my interest. I’m going
    to book mark your website and keep checking for new information about once a week.
    I subscribed to your Feed as well.

Comments are closed.