| A venture capitalist reveals what you need to know | | | | Here's one option to consider when trying to value |
| | | | your company for a seed-round investment. Avoid it |
| Founder of Capital Now and author of Capital Now | | | | altogether; after all, it doesn't make sense and can |
| Complete | | | | only present a potential liability down the road. |
| Free Trial copy available at | | | | Instead of offering equity, offer debt that can be |
| The use of friends, business associates and Angels | | | | converted into equity at some point in the future. |
| as sources of financing often appears attractive as a | | | | This is a much more secure financial instrument, |
| relatively uncomplicated, readily available capital | | | | which will provide a lien on the assets to the Angels if |
| source. For startups, they are often the only form of | | | | the business does not progress. The lien would be |
| capital available. Yet, care must be taken to ensure | | | | released upon a debt-to-equity conversion that could |
| that this early round of capital does not interfere | | | | take place at the first round of a venture capital |
| with long-term financing. Angel financing is typically a | | | | investment. The conversion price can based on the |
| one-time source, in which the investors have | | | | pre-money value paid by a VC, adjusted with a |
| unrealistic return expectations. Typically, these | | | | discount based on how much time passes until |
| sources are not professional investors with diversified | | | | conversion. |
| and balanced portfolios. They can hardly be blamed | | | | For example, let's assume that an Angel investor |
| for nervousness over the inevitable ups and downs | | | | group provides a convertible loan in the amount of |
| of the your company's development cycle; however, | | | | $1,000,000, and one year later a VC buys 2,000,000 |
| as friends or previously successful entrepreneurs | | | | shares of stock at $1 per share. The Angels could |
| themselves, you can be sure that they will make | | | | then have the option to convert the $1,000,000 loan |
| their advice and concerns well known to the | | | | into shares at a price discounted from the $1 price |
| company. | | | | that the VC paid. Assuming further that the discount |
| Part of the problem some of you encounter is that | | | | is 20%, the Angels would then convert this loan into |
| you tend to over-value the company for the Angel | | | | 1,250,000 shares of stock at 80 cents per share. |
| round. Then you are placed in the uncomfortable | | | | This strategy avoids the problem of applying an |
| position of explaining to people who often do not | | | | improper valuation too early in the life of the |
| understand venture capital that they have to take | | | | company. Using debt instead of equity for Angels will |
| what they would consider to be a valuation "haircut." | | | | provide an equitable solution for all investors and help |
| We've encountered entrepreneurs that say, "We've | | | | you avoid a major headache. The Angel is protected, |
| just raised a $10 million pre-money valuation, and now | | | | assuming that a future investment takes place, |
| we're going to go out and get a $15 million valuation." | | | | because they see an increase in the value of their |
| Then we learn they only raised $500,000 at the $10 | | | | investment. The venture capitalist is pleased because |
| million pre-money valuation. That's not a solid basis for | | | | the Angel did not buy stock at an abnormally low |
| a $10 million pre-money valuation. Yet there are some | | | | price relative to the valuation the VC is applying. And |
| of you who mistakenly believe it is a solid valuation | | | | you are content because you have your money and |
| and potentially put the company in jeopardy to fail in | | | | your investors are happy. |
| the next financial round. | | | | Copyright ©2004 by CTC Publishing, All Rights |
| Angel Round Strategy | | | | Reserved. |