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!
I seriously love your site.. Pleasant colors & theme.
Did you build this site yourself? Please reply back as I’m trying to create
my very own blog and would like to find out where you got this from or what the theme is named.
Kudos!
Hi there, i read your blog occasionally and i own a similar one and i was just wondering if you get a lot of spam comments?
If so how do you stop it, any plugin or anything you can recommend?
I get so much lately it’s driving me insane so any assistance is very much appreciated.
Wow, this post is nice, my younger sister
is analyzing these things, thus I am going to let know her.
Pretty section of content. I just stumbled upon your blog and in accession capital to assert that I
get in fact enjoyed account your blog posts. Any
way I will be subscribing to your feeds and even I achievement you access consistently quickly.
I’m not sure exactly why but this site is loading very slow for
me. Is anyone else having this issue or is it a problem on my end?
I’ll check back later on and see if the problem still exists.
I simply couldn’t depart your web site prior to suggesting
that I actually loved the standard information an individual provide in your visitors?
Is going to be again often to check out new posts
Hi there, I enjoy reading all of your post. I like to write a little comment to support
you.
Useful information. Lucky me I discovered your website unintentionally, and I am surprised why this twist of fate did not took place in advance!
I bookmarked it.
Hi! I could have sworn I’ve been to your blog before but after looking at
some of the posts I realized it’s new to me. Anyhow, I’m certainly delighted
I came across it and I’ll be bookmarking it and checking back often!
It’s really very complex in this busy life to listen news
on TV, therefore I only use web for that purpose, and obtain the
most recent news.
What i do not understood is actually how you’re not really much more neatly-appreciated than you might be
right now. You’re so intelligent. You recognize therefore considerably when it
comes to this subject, made me personally consider it from a lot of numerous angles.
Its like women and men are not involved except it’s
one thing to accomplish with Lady gaga! Your personal stuffs excellent.
Always maintain it up!
An impressive share! I have just forwarded this onto a colleague who has been conducting a little research on this.
And he in fact bought me dinner because I stumbled upon it for him…
lol. So allow me to reword this…. Thank YOU for the meal!!
But yeah, thanks for spending some time to talk about this issue here on your web site.
Incredible quest there. What occurred after? Take care!
I just couldn’t leave your web site prior to suggesting that I really enjoyed the
usual information an individual supply for your
guests? Is gonna be back frequently in order to
check up on new posts
Hi superb website! Does running a blog like this take a lot of work?
I have no expertise in coding but I had been hoping to start my own blog
in the near future. Anyways, should you have any suggestions or techniques
for new blog owners please share. I understand this is off topic
nevertheless I just needed to ask. Many thanks!
Wow, amazing blog layout! How long have you been blogging for?
you make blogging look easy. The overall look of your website is excellent, let alone the content!
Thanks to my father who stated to me concerning this
blog, this website is in fact amazing.
Amazing! This blog looks exactly like my old
one! It’s on a totally different topic but it has pretty
much the same layout and design. Outstanding choice of colors!
It’s going to be ending of mine day, however before
finish I am reading this fantastic post to increase my know-how.
It’s truly very complex in this busy life to listen news on Television, therefore I only use the web for that reason, and take the hottest news.
I’ve been exploring for a little for any high quality articles or
weblog posts in this sort of house . Exploring in Yahoo I finally stumbled upon this web site.
Reading this info So i’m satisfied to convey that I
have a very just right uncanny feeling I discovered
just what I needed. I such a lot undoubtedly will make certain to do not overlook this website and give it a look on a continuing basis.
I’m no longer sure where you are getting your information, however great topic.
I needs to spend some time learning much more or working out more.
Thank you for magnificent info I used to be in search of this information for my mission.
Truly when someone doesn’t be aware of afterward its up to other people that
they will help, so here it happens.
It is appropriate time to make some plans for the future and it’s
time to be happy. I’ve read this post and if
I could I want to suggest you some interesting things or advice.
Perhaps you could write next articles referring to this article.
I want to read more things about it!
Wow, awesome weblog layout! How long have you been blogging for?
you made blogging glance easy. The full glance of
your web site is magnificent, as neatly as the content!
Hi to all, because I am truly eager of reading this weblog’s post to be updated
daily. It consists of pleasant stuff.
An outstanding share! I have just forwarded this onto
a co-worker who had been conducting a little research on this.
And he in fact bought me lunch due to the fact that I found it for him…
lol. So let me reword this…. Thanks for the meal!!
But yeah, thanx for spending the time to discuss this issue
here on your site.
The other day, while I was at work, my sister stole my
iphone and tested to see if it can survive a thirty foot drop, just so she can be a
youtube sensation. My iPad is now destroyed and she has 83 views.
I know this is totally off topic but I had to share it with someone!
Hi all, here every person is sharing these know-how,
therefore it’s nice to read this website, and
I used to go to see this website daily.
I’m now not positive the place you’re getting your
info, however great topic. I must spend a while
finding out much more or figuring out more.
Thanks for magnificent info I used to be looking
for this information for my mission.
Terrific article! This is the kind of information that are supposed to be shared around the internet.
Disgrace on the seek engines for no longer positioning this
submit upper! Come on over and visit my site . Thank you =)
Hello There. I discovered your blog the use of msn. That is a very smartly written article.
I’ll be sure to bookmark it and return to read more of your useful
info. Thank you for the post. I’ll certainly return.
It is not my first time to go to see this web site, i am browsing this web site dailly and take pleasant facts from here all the time.
Magnificent items from you, man. I have be mindful your stuff previous to and you are just too great.
I actually like what you’ve got right here, certainly like what you’re
saying and the way in which through which you say it.
You make it entertaining and you continue to care
for to keep it sensible. I can not wait to learn much more from you.
That is really a wonderful web site.
Hey there! I know this is somewhat off topic but
I was wondering if you knew where I could locate a captcha
plugin for my comment form? I’m using the same blog platform as yours and
I’m having trouble finding one? Thanks a lot!
Howdy just wanted to give you a quick heads
up. The text in your article seem to be running off the screen in Internet explorer.
I’m not sure if this is a format issue or something to do with internet browser
compatibility but I figured I’d post to let you know.
The design and style look great though! Hope you get the problem fixed soon. Thanks
Good site you have here.. It’s hard to find high quality writing like
yours nowadays. I really appreciate individuals
like you! Take care!!
Hi there, I enjoy reading through your article.
I like to write a little comment to support you.
I couldn’t refrain from commenting. Very
well written!
Everything is very open with a very clear explanation of the challenges.
It was definitely informative. Your site is extremely helpful.
Thanks for sharing!
Link exchange is nothing else however it is simply placing the other person’s blog
link on your page at proper place and other person will also do same in favor of you.
Woah! I’m really digging the template/theme of this blog.
It’s simple, yet effective. A lot of times it’s tough to
get that “perfect balance” between user friendliness and visual appearance.
I must say you have done a excellent job with this.
In addition, the blog loads super quick for me on Internet explorer.
Outstanding Blog!
If some one wants to be updated with newest technologies after that he must be pay a quick visit this web site and be up to date every day.
I visit everyday a few sites and blogs to read posts, but this website gives
quality based content.
This website was… how do you say it? Relevant!! Finally I have found something that helped me.
Appreciate it!
Hello there! Quick question that’s totally off topic.
Do you know how to make your site mobile friendly? My website looks weird when browsing from my apple iphone.
I’m trying to find a theme or plugin that might be able to correct this issue.
If you have any recommendations, please share.
Thank you!
Please let me know if you’re looking for a author for your weblog.
You have some really good posts and I believe I would be a good asset.
If you ever want to take some of the load off, I’d really like to
write some material for your blog in exchange for a link back to
mine. Please shoot me an e-mail if interested. Many thanks!
Hi, all is going sound here and ofcourse every
one is sharing information, that’s in fact good, keep up writing.
Hi there, You have done a fantastic job. I will definitely digg it and personally recommend to my friends.
I’m confident they will be benefited from this site.
Neat blog! Is your theme custom made or did you download it from somewhere?
A design like yours with a few simple tweeks would really
make my blog shine. Please let me know where
you got your design. Many thanks