Tag Archives: Angel Investing

The Facts on Deal Valuation and Structure

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Attention Entrepreneurs:  Investors at different stages have varied interests so you are likely to get different counsel from Big VCs, Big Accelerators, and other Big Shots.

I’ll keep this post brief and fact-based.  Early stage financing has supply and demand, and deal terms and valuation are determined by market factors.  When you determine valuation and deal structure for your company, consider the current data on Angel financing.

66% of Angel financings are done at a pre-money valuation of $4.5 million and under.60% of angel financing is done with Preferred Stock.

The source of this data is the Angel Capital Association’s new Angel Funders Report, dated August 2018 and released October 2018.  Drawn from 432 investment rounds in 2017 across 393 companies totaling $102 million invested.  Companies were located in 36 US States, Canada, and Israel.

So when you set your terms, the closer you can price your deal based on its merits relative to other angel deals getting funded, the faster your funding round will go, and the quicker you can get back to your business fundamentals.

QSBS: The Death Knell for Convertible Notes in Early Stage Investing?

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no exit taxThe 2015 tax bill contains a giant incentive for early stage tech investors.  Investment gains on exit, subject to certain conditions, are now exempt from capital gains tax and the investment tax.  This means a reduction in federal tax from 23.8% to zero.  Congress apparently feels that early stage investing in tech businesses is an engine of growth for the US economy and US jobs, and removing the 23.8% tax on gains will be a net positive for the country.  This Qualified Small Business Stock (QSBS) tax treatment has been on and off again for years, but is now a permanent part of the tax code since the Protecting America from Tax Hikes Act of 2015 was passed in December 2015.

So, what’s the catch?

  1. The exemption applies only to the first $10 million of gain
  2. The stock must be held for at least five years (most successful angel exits take longer than 5 years)
  3. The stock must be purchased after September 27, 2010 directly from the company
  4. The stock must be in a C Corporation
  5. The stock must be, well, stock. (It cannot be a convertible note!)

The company must be a qualified small business, as defined by Section 1202.  Some requirements are that it have gross assets of under $50 million, and not be in any traditional business categories like a local restaurant, motel, bank, farm, or doctor’s office.

Consult your tax adviser for more information, of course, but by making this tax incentive permanent, early stage investors and entrepreneur’s have a shared and vested stake in working to make sure their investment structure takes advantage of this, as well as aiming for big gains on an exit after 5 years.

Many angel groups and sophisticated angel investors avoid convertible notes and SAFEs since they typically do not afford the protections and advantages of investments in preferred stock.  This new legislation adds a considerable advantage to equity investment – the prospect of tax free gains on exit.

To begin to get equivalence for investors, the typical “discount” in a convertible note would need to increase from 20% to more than 40%.  And that just might be the death knell for convertible notes in early stage investing.

For more information, see Alan Patricof’s column for TechCrunch, this Forbes article from Lowenstein Sandler, or wealthfront.  The Angels Capital Association has posted a very comprehensive 9 page memo on the details of how to qualify for Section 1202 from accountants Godfrey & Kahn written for Golden Angels.  And VC Fred Wilson of Union Square Ventures has a well-reasoned post here “Unsafe Notes” explaining why convertible and SAFE notes are not in the best interest of founders.

New York Angels is the Most Active Angel Group in the USA in 2012

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Most Active Angel Groups 2012

New York Angels is the most active angel group in the USA according to the Halo Group’s 2012 Year in Review, based on number of investments.

Source:  The Halo Group, 2012 Year in Review

Who Gets Better Returns, Professional VCs or Angel Investors?

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Early stage venture capitalist John Frankel (@john_frankel) has compiled some very rich data on the returns of early stage and venture investing.  Some key points:

  • Venture capital funds, in aggregate, managed an anemic 4.4% end-to-end pooled return over the last 10 years
  • As one Kauffman Foundation report sums it up, “since 1997, less cash has been returned to investors than has been invested in VC.”
  •  A typical firm now makes two-thirds of its revenue from annual management fees rather than performance-based carried interest.  The larger the fund, the more likely it is that income is tied to fund size rather than performance. The incentive becomes raising larger funds rather than generating stronger returns.
  • Angel groups, on the other hand, have done exceptionally well.  Every large angel return study has mean angel IRRs ranging from 18 percent to 38 percent.  Amongst angels, top performers conduct more due diligence before investing and are subsequently more actively involved with ventures.

You can see the detailed charts of returns here.

Angel Valuation Survey

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The median valuation of tech companies funded pre-revenue is $2.75 million, according to a just released survey of angel groups from Gust. With the costs of starting a tech business falling, this means an entrepreneur can raise $500k and only give up 18% of his company to do so.  With the promise of revenue down the road, and no financial history on which to base a valuation, this seems reasonable.  Every company is of course different, but if an entrepreneur can conserve capital, he or she can retain a large share of the company.  Since I’m often asked about valuation, I’ve posted data from some of the larger angel groups below:

2012 Valuation Survey of Angel Groups  
Median pre-money valuation of pre-revenue companies
Software, Internet, Mobile and telecom deals
$ millions
All Groups:  Median 2.75  
All Groups:  Average 2.96
Selected groups:
Alliance of Angels (Seattle) 0.8
Atlanta Technology Angels 1.8
Robin Hood Ventures (Phila) 2
Vancouver Angels 2
Ohio TechAngels (Columbus) 2.45
New York Angels 2.45
Band of Angels (Silicon Valley) 2.75
Launchpad Angels (Boston) 2.75
Mid-Atlantic Angel Group (Phila) 3
Hub Angels (Boston) 3.13
Golden Seeds (NY, Boston, CA) 3.35
Sand Hill Angels (Silicon Valley) 3.5
Tech Coast Angels (So. CA) 3.6

Angel Investors Earn 2.5x Returns

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Robert Wiltbank, PhD, a professor at Willamette University and a board member of the Angel Resource Institute, studied more than 1,200 exited investments made by angel investors over a 15-year timeframe.

His key findings:

  1. The best estimate of overall angel investor returns from this data is 2.5 times their investment.
  2. This 2.5x return takes a mean time of about four years.
  3. In any one investment the odds of a positive return are less than 50 percent. 
  4. 90 percent of all the cash returns are produced by 10 percent of the exits
  5. Once investors had a portfolio of at least six investments, their median return exceeded 1X.

His summary:  Angel investing “is a “homerun” game like formal venture capital investing. Second, a portfolio of investments, even in angel investing, is a great approach. Third, whenever you’re making risky investments it is a great principle to limit your bet size and make sure that you don’t put too much of your wealth into aggressive positions.”

More from TechCrunch here.

Angel Valuations Inch Up

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How much to Angels typically invest and at what company valuation?  Angel valuations are inching up per the Halo Report for Q2 2012:

  • Company valuations for early stage financing rounds with Angels are $2.7 million in Q2 2012, up from $2.5 million in Q1 (median, pre-money valuations).
  • Typical angel investment rounds total $550,000 for Angel-only rounds and $1.5 million with VC’s involved (these are median values; the mean values are higher at  $1 million and $4 million.
  • And VC’s have Angels co-invest in 72.5% of their deals.
  • And half of Angel  deals are in tech-related fields  (Internet, Software, Mobile, Telecom).

You can download a 16-page pdf of highlights here.

3 Reasons to Look to the Angels for Start-up Funding

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From Inc. Magazine, here are 3 reasons why angel investors can help you build your startup:

  1. Operational Expertise.  Angels with operational experience, especially within your industry, can provide invaluable contacts and advice, and angel investors are almost always current or former industry executives themselves.
  2. Patience.  Angels don’t expect to get their money out within three to five years at some pre-determined rate of return. As long as your company is doing well, most angels are happy to let their investment “ride” for the long haul. For the most part, angels are patient, long-term investors.
  3. Valuation and Ownership. Angels will usually give you a better valuation and financing terms, allowing you to retain more of the equity and board control of your company. 

Read the full piece by Langley Steinert, CarGurus.com founder, here.

The Decade of the Angel Investor

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Investor Paul Singh covers the common wisdom about angel investing.  Very sensible.  A good plan.  Hard to argue.  Let’s call it the base case…

  • “The takeaway for angels is you shouldn’t get into this asset class unless you’re willing to do 20 deals,” Singh said. “Do not get excited about any one company.”
  • “What I’m doing is going to the blackjack table, playing the minimum hand while I count the cards,” Singh said. “When I see a pattern I double down heavy.”
  • “Bad bets fail fast,” Singh said. “Smaller check sizes force companies to figure stuff out quickly.”

More here.