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!
It’s really a great and helpful piece of information. I’m satisfied that you
shared this helpful information with us. Please stay us informed like this.
Thanks for sharing.
I’m really impressed with your writing talents and also
with the layout to your weblog. Is this a paid theme or did you customize
it your self? Anyway stay up the nice high quality
writing, it’s rare to peer a nice weblog like this one nowadays..
whoah this weblog is great i like studying your articles.
Stay up the good work! You already know, lots of
individuals are hunting around for this information, you
could aid them greatly.
Hi, this weekend is fastidious in favor of me, since this time i am reading this enormous
educational article here at my residence.
Does your blog have a contact page? I’m having problems
locating it but, I’d like to send you an e-mail.
I’ve got some suggestions for your blog you might be interested in hearing.
Either way, great website and I look forward to seeing it grow over time.
This website was… how do I say it? Relevant!! Finally I’ve found something that helped me.
Cheers!
Hey there just wanted to give you a quick heads up and let you know a few of the images aren’t
loading properly. I’m not sure why but I think its a linking issue.
I’ve tried it in two different browsers and both show the
same results.
It’s awesome to pay a visit this web page and reading the views of all colleagues on the topic of this post, while I am also zealous of getting experience.
Hello, after reading this awesome piece of writing i am
also cheerful to share my knowledge here with colleagues.
It’s remarkable in support of me to have a website, which is helpful
in favor of my experience. thanks admin
Great blog here! Additionally your website quite a bit up very fast!
What host are you using? Can I get your associate hyperlink for your host?
I wish my web site loaded up as quickly as yours lol
Howdy just wanted to give you a quick heads up.
The text in your article seem to be running off the screen in Firefox.
I’m not sure if this is a format issue or something to do with web browser compatibility but I thought I’d post
to let you know. The style and design look great though!
Hope you get the problem resolved soon. Kudos
Good day! I could have sworn I’ve been to this
blog before but after going through a few of the posts I realized it’s new to me.
Nonetheless, I’m definitely delighted I
stumbled upon it and I’ll be book-marking it and checking back
frequently!
It’s in fact very difficult in this active life to listen news on TV, thus I only
use web for that purpose, and take the hottest information.
Fastidious response in return of this difficulty with
real arguments and telling the whole thing on the topic of that.
It’s going to be end of mine day, except before ending I am reading this wonderful article to
increase my know-how.
certainly like your website however you need to test the spelling on quite a few of your posts.
Many of them are rife with spelling issues and I to find it very
troublesome to inform the truth then again I
will surely come again again.
I’m truly enjoying the design and layout of your website.
It’s a very easy on the eyes which makes it much more pleasant for me to come here and visit more often. Did you hire out a designer to create your theme?
Great work!
Greetings! Very useful advice within this post! It is the little changes
that will make the most significant changes. Thanks a lot for sharing!
It is not my first time to go to see this website, i am visiting this site dailly and obtain good data from here every
day.
Thank you for the good writeup. It in fact was a amusement account it.
Look advanced to far added agreeable from you! However,
how can we communicate?
Greetings from Los angeles! I’m bored to tears at work so
I decided to check out your website on my iphone during lunch break.
I love the knowledge you provide here and can’t wait to take a look when I get
home. I’m surprised at how fast your blog loaded on my cell
phone .. I’m not even using WIFI, just 3G .. Anyways, good site!
Hi colleagues, its fantastic article about educationand fully explained,
keep it up all the time.
Saved as a favorite, I like your blog!
It’s hard to come by well-informed people about this subject,
however, you sound like you know what you’re talking about!
Thanks
Greetings! Very useful advice in this particular article!
It’s the little changes which will make the largest changes.
Many thanks for sharing!
Hey there! Do you know if they make any plugins
to assist with SEO? I’m trying to get my blog to
rank for some targeted keywords but I’m not seeing very good success.
If you know of any please share. Thank you!
Great blog you’ve got here.. It’s hard to find excellent writing like yours
nowadays. I seriously appreciate people like you! Take care!!
You can certainly see your expertise within the article
you write. The world hopes for even more passionate writers such as you who are not afraid to say how they believe.
At all times go after your heart.
My brother suggested I might like this web site.
He was entirely right. This post truly made my day. You cann’t imagine just
how much time I had spent for this info!
Thanks!
Keep on writing, great job!
If some one wishes expert view concerning running a blog then i advise him/her to pay a
quick visit this weblog, Keep up the nice
job.
This is very interesting, You are a very skilled blogger.
I’ve joined your rss feed and look forward to seeking more
of your great post. Also, I’ve shared your website
in my social networks!
Greetings! I know this is kinda off topic but I’d figured I’d ask.
Would you be interested in trading links or maybe guest writing
a blog post or vice-versa? My website discusses a lot of the same topics as yours and I feel we could
greatly benefit from each other. If you happen to be interested
feel free to send me an e-mail. I look forward to hearing from you!
Fantastic blog by the way!
It’s difficult to find knowledgeable people about this topic,
but you seem like you know what you’re talking about! Thanks
Thank you a lot for sharing this with all folks you really
know what you’re speaking approximately! Bookmarked.
Please additionally visit my web site =). We will
have a link alternate arrangement between us
Fantastic site you have here but I was wondering if you knew of any
discussion boards that cover the same topics discussed in this article?
I’d really love to be a part of online community where I can get opinions from other experienced individuals that share the same interest.
If you have any suggestions, please let me know. Thanks!
Heya i’m for the first time here. I found this board and I find It truly useful &
it helped me out a lot. I hope to give something back
and help others like you helped me.
whoah this blog is wonderful i like reading your articles.
Stay up the good work! You realize, lots of individuals are searching round for this
information, you could aid them greatly.
Appreciate the recommendation. Let me try it out.
These are actually enormous ideas in concerning blogging.
You have touched some pleasant points here.
Any way keep up wrinting.
Hurrah! After all I got a web site from where I can truly get valuable data concerning my study and knowledge.
Hi there very cool web site!! Guy .. Excellent ..
Wonderful .. I will bookmark your web site and take the feeds additionally?
I’m satisfied to seek out numerous useful information right here in the post, we need work out more strategies on this regard, thank you for sharing.
. . . . .
hello!,I really like your writing very so much! share we keep up a correspondence extra about your
article on AOL? I need an expert on this space to
solve my problem. May be that is you! Having a look ahead to see you.
Every weekend i used to pay a visit this site, because i
want enjoyment, for the reason that this this website
conations really pleasant funny material too.
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 four emails with the same comment.
Is there any way you can remove me from that service?
Thank you!
Good post. I learn something totally new and challenging on blogs I stumbleupon every day.
It will always be exciting to read articles from other authors and use something from
other sites.
Good post. I absolutely love this website. Continue the good
work!
I’m pretty pleased to find this great site. I want to to thank you for
ones time for this wonderful read!! I definitely savored every part of it and I have you book-marked to
look at new things in your web site.
Great article, just what I wanted to find.