I want to ask an angel investor I know for a $25k convertible note w/ 75% discount and 1.5m cap. Are these relatively attractive terms or should I modify that to make it more appealing?

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JASON LEMKIN

I actually like this idea, but it is very situationally dependent.

Most angels that are serious about it — i.e., making 5-10x on their angel investments as a cohort, not just Playing Angel — generally have some serious rules.  If you don’t stick to them, you end up investing in 20-40 Cool Companies That All [Claim to] Cure Cancer or Other Amazing Things … and lose all your money.

One way to be serious is to stick to certain valuation caps to make sure you are doing “the right thing” on pricing.  Here, your angel only wants to invest at $500k or lower valuations, probably so she can achieve an initial 5% ownership stake.   She then knows if 1 or 2 of her 25 x $25,000 angel investments ($625,000 total invested) “hit” and post-dilution, she owns on average 3% of each one … then with say even one $100m exit in the batch, she can hit her 5x target.

If that’s the case — she’ll (likely) pass on your offer.  It may be “fair” (who knows) but it breaks her model.  Owning only 1% post dilution in your company means a $100m exit just starts to get past 1x her money back on her whole angel portfolio … not the 5x target she’s looking for.

On the other hand …

The more absolute dollars you invest, and the more you are Unicorn Hunting … the more all you want in your smaller investments is Good and Fair terms.  E.g., as a VC I might be responsible for deploying $50m of a $150m early-stage fund.  In that case, $25k would be too tiny of an investment, and even investing $150k here would be pretty small.  For a smaller investment, a 75% discount and a $1.5m cap might be all I need to know.  Done deal.  I’m either getting in at a good enough price ($1.5m) if I see Unicorn potential, and/or, I’m getting such a large discount (75%) that I’m a “genius”.  What I really hate in these small investments is just looking stupid.  So … Good Enough — and I’ll focus more on the details when I try to invest $3m in your first real round.

So net net, entry prices are incredibly important in angel and VC investing.  As you can see in the above example, for the Angel in the first case — it’s the difference between a 1.5x return and a 5x return on her capital.

You’ll also similarly see a lot of micro and pre-seed VCs stick to fierce and firm valuation rules for the same reasons.

But how important a given price matters to one investor over another varies based on how many Unicorns you are hunting — if any — and when and how, and with how many nickels.  Getting in at almost any pre-Unicorn price in Facebook, WhatsApp, Uber etc. etc. … totally blows away our angel’s 5x returns.

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Published on November 29, 2015
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