goodcounsel represents a wide range of startups, many of which have raised capital from angel investors. How do these investments perform? It is difficult for us to generalize from our limited view of the landscape. We don’t have a large enough sample size (or the expertise, to be frank) to make broad judgments.
Fortunately, there are organizations who compile data and study issues like this. One of them, an organization called the Angel Resource Institute, recently issued a report called “Tracking Angel Returns.” You can read it yourself, here, but the upshot, based on a combined data set of 245 completed investments:
The overall cash on cash multiple is 2.5X, with an average holding period of 4.5 years. This equates to an Internal Rate of Return (IRR) of 22%, which is obviously very good.
Failure rates, not surprisingly, are high: 70%.
Of the non-failures, a mere 10% generated 85% of all cash, which again, is not completely surprising. This explains why smart early-stage investors typically pursue a portfolio strategy.
This suggests that a broad portfolio of angel investments offers attractive performance; by the same token, making a single, undiversified investment could be risky risky (true of a single investment in any asset class).
What factors go into making the successful startup? We’ll explore that in a separate post.
Fred Wilson (always worth reading) has once again posted some views in the (perhaps a bit tired) debate about whether entrepreneurs should raise seed financing using convertible notes (or their close cousins, SAFEs) or priced equity. (Wilson’s original post was all the way back in August 2010.) Amazingly, though posted only a month ago, there are 98 comment threads (and the comments are closed, otherwise there would surely be more).
Wilson, though a venture capital investor, makes the argument that convertible notes and SAFEs (which are more or less identical for purposes of this conversation) are bad for thefounders. I have no reason to think that he’s being insincere or self-serving; he has a good reputation, and he makes some valid points. At the same time, one can find any number of people arguing that convertible notes are a bad deal for investors, and no investor ought to invest through one. Here’s a recent example, from David Cummings in Atlanta. (Don’t know him, but his bio is impressive enough.)
Who to believe?
I’ve posted on this subject before. Re-reading that now, years later, I still agree with myself (Hooray!). Below is a more concise take, as posted in a comment to the Cummings thread I wrote today:
All of these posts [pro and con] tend to ignore the compelling reasons that entrepreneurs turn to convertible notes.
Note documentation is easy to understand (the number of moving parts is quite low) and, most importantly, relatively inexpensive. By contrast, doing an equity round generally involves changes to a company’s certificate of incorporation and — if any of the standard document sets are used (most of which I find to be investor-favorable to a greater or lesser degree) — three or four additional, long documents will also be involved. The legal fees easily get to $20K or more, when both company and investor counsel are included.
Personally, I’ve done much lighter equity documents for startups, quite inexpensively, but these are for seed rounds, where the company tends to be in the driver’s seat and a lot of terms can be left out. I am sure that if a VC investor were involved, they would find them lacking (in their view) sufficient protections.
The problem with equity rounds is complexity and cost, and until those issues are addressed, companies will keep using notes and SAFEs, even if in some cases they have terms that may be less than ideal for one side or the other.
In the comments to Wilson’s post, you will find heavy-duty debate about whether or under what scenarios the dilution mathematics of convertible notes works out better for investors or founders. (Spoiler: it depends.) I simply feel that my take reflects a more practical perspective on why people go for convertible notes. It’s generally not a decision based upon intensive spreadsheet work using a variety of assumptions about company growth and future rounds and valuations; it’s about how to get the round done and the money in the door, quickly and economically. That seems to trump all other considerations.
In a legal and business career that spans more years than I care to admit, I’ve worn many hats (some of them at the same time): entrepreneur, company founder, early employee, investor, and attorney. Understanding an issue from multiple directions means that, perhaps unusually among lawyers, we typically counsel our startup company clients to implement legal terms that, while not representing the most aggressive possible stance, represent a fair one – one that we feel will ultimately result in the best outcome for all parties, including our client. Read the rest of this entry »
You’ve landed that dream job and you’re excited to get started. The company is even throwing in some stock options! Since you will be an instrumental part of the company, you might think that the company is poised to take off and those options are going to be super valuable. “Sweet,” you say to yourself. “Where do I sign?”
Well, not to rain on your employment parade, but you might want to take a moment to review the structure of those options, and to understand what exercising an option really means.
The adage, “you have to have money to make money” really hits home when you are reviewing the budget needed to launch a business. Starting a business is expensive, and we understand that many of the entrepreneurs and businesspeople that we represent are trying to “bootstrap it,” especially at the outset of a new venture. Saving money is always on the entrepreneur’s mind, and every dollar counts. The annual fee for a registered agent averages about $250, and since most people don’t understand the value of registered agent services, this is one expense that entrepreneurs are tempted to save by doing it themselves. In this post, I’d like to talk about why that $250 can save you more than $250 worth of time, money, and grief in the future.
UPDATE 10/26/16: Credits are used up for 2016, and the Illinois Angel Investment Credit Program is scheduled to expire on December 31, 2016. It remains to be seen whether the Illinois legislature might reauthorize the program.
We’ve written in a past edition of our goodnews newsletter about an Illinois program to encourage investment in innovative early-stage companies, the Illinois Angel Tax Credit Program. Illinois has recently made an important change, which could affect the way that companies would want to structure an early investment round.
In the days of yore, when dinosaurs roamed the earth (or thereabouts), goodcounsel offered “fractional general counsel” services. The idea of providing part-time counsel to growing, entrepreneurial companies (like those for which I had previously worked) was sound, but offering it a certain number of days each month was, in retrospect, flawed. If the billable hour is a bad measure of value (which, as a rule, it is), the billable day is not necessarily much of an improvement.
We soon got quite busy with client work of various kinds (on a fixed-fee basis, of course), and the fractional general counsel services fell by the wayside.
Would you like to accept small investments in your company from your Aunt Rose, your brother-in-law Bobby and your best friend from high school? Many people are surprised to learn that, unless these friends and family members are high-net worth investors, this is not the kind of thing that is safe to do – not, at least, if you want to be fastidious about observing securities regulations. Read the rest of this entry »
With some regularity, clients tell me that they want to issue employee equity that represents a fixed percentage of the company, not subject to dilution. What startup company founders should realize is that giving out equity containing an “anti-dilution” feature is an extraordinary and unusual benefit, one that should be agreed to only in exceptional circumstances.