Category Archives: Angel Investing/Venture Funds

Convertible Notes versus Preferred Equity Part III: The Investor

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In the last few months in working with financings, I have gotten to know the Convertible Notes versus Preferred Equity issue very well. As an angel investor, I am constantly thinking about maximizing my money and I don’t have the cash to play the field in a broad, diversified way to not care about this issue like some larger angels. Thus, knowing when to take a deal or walk away is part of the game, and certainly financing terms are part of that decision.
Again, I reference Josh Kopelman’s post on Notes and Preferred Equity and think it explains many details well. I’ll talk about this topic with his thoughts and some of my own in mind.
Why would I be OK with a Note?
The terms must be good.
Often Notes have no anti-dilution provisions or special provisions that help us in case the next equity financing does not occur. They seem to be hastily drawn up and many details are left out. I have walked away from Notes that didn’t have enough good terms in there.
They are mostly unsecured, so I’m OK with that. I know that I’m dealing with an early stage startup and they have little or no assets at this point. What would I do with 1/10th of a PC?
I also want to make sure I am not locked into a particular Next Equity Financing by default. I want to have the ability to back out if company conditions change.
If they require an auto-conversion provision in their to the Next Equity Financing, then I want them to insert a minimum on the money raised, to ensure that they don’t do something screwy.
In truth, I don’t pay much attention to the interest rate return for early stage startups. This is usually a make or break time for them. If they don’t get the Next Equity Financing, then often the company will tank and I won’t get any interest payment or my money back yet. I do just make sure it is in range of other Notes I’ve seen which is about 6-8% per annum.
There is a Preferred Series financing imminent.
Most Notes are used to gain cash to continue company operations just prior to a first Preferred Series financing. My goal is to always get share of a Preferred Series. If I know there is one coming soon, then I’m OK with a Note knowing that I’ll convert in a few months. Time is minimized between the Note and the Preferred Series and there is a less of a chance that the company valuation will change dramatically, causing loss in ownership share from when I invested and when it converts.
Why would I NOT be OK with a Note?
There is no Preferred Series in sight, or I am not confident it will happen soon.
If the Note is being raised, but they have nebulous plans for raising the next Preferred Series. I won’t do it. The risk of it dragging on for a long time is there, and the more time that drags on before I gain actual ownership in the company, the more chance that it goes not in my favor. The valuation could go up (meaning I convert to less ownership than I originally thought), the company could go under with not enough funds, or I mayjust get paid back and not reap any benefits of having ownership in the company, if the company starts gaining revenue. The company need not be going under for you to not gain the benefits of investing in a company.
Or they may SAY they are going for Preferred Equity fund raising, but I get the feeling they will drag their heels or avoid seriously doing it. As soon as I get some intuition that this is true, I won’t do it.
This is a second (or beyond) Note they are raising.
This begs many questions. Is the company trying to be greedy and not give up any ownership? If so, they can build their company on other people’s money then. I want to maximize return and getting interest rate return on my money is not the way to go.
Or you have to wonder why this is yet another Note. Why do they need another Note? Why haven’t they raised their Series A? Or what is wrong with them that they can’t raise their Series A? Many Notes are written vaguely that the Note will convert to Next Equity Financing. They may actually want to convert the last Note holders to the terms of the second Note which may be less favorable to them!
Unfavorable Terms.
Although this may seem like a given, it could mean that the company opportunity is really good, but the Note terms are not.
Terms always take care of the worst case scenario and nobody wants to see them come into action. But sometimes, the terms are there and you can’t change them. I’ve already had a case where I wanted to change the terms but the entrepreneur did not because the current terms were already approved by the lead investor, and he did not want to scare the lead investor off. But, it was obvious that the lead investor didn’t really read the term sheet carefully because some of those terms were bad even for him.
By the way, I think this happens frequently in the Valley. There are so many large investors that when they invest, it is a small amount for them but large enough to make them lead investor. But they go through so many deals that they don’t seem to be spending time on the terms at all. I’ve heard from one person that they just write off investments that get diluted to nothing or fail, and employ diversified investing across many different investments and hope that a few make it big to cover the many that return little. Very frustrating for us smaller angel investors.
Always be ready to walk away no matter how good parts of the deal looks…
Investors are not aligned with interests of the company in building value.
Clearly stated in Josh Kopelman’s post, it makes sense that as investor I want the valuation kept as low as possible so that I convert to as high ownership as possible. But my model is to help entrepreneurs as much as possible. So if I end up helping them and sign up as advisor, but feel that a Note they may be presenting may not be in my best interests, I may end up not investing at all.
Why I like Preferred Series.
I have ownership in the company.
I gain immediate ownership in the company and this point is not nebulous, as in the situation of the Note.
Generally, preferred terms are pretty favorable to me.
There will be provisions for voting, company control, preference in paying back, potential dividends, etc.
I am aligned with the interests of the company.
Once I have ownership in the company, I can freely and without reservation help the company build value, as my own value in the company will also grow.
Why not Preferred Equity?
Not many reasons to not jump into an investment if Preferred Equity is offered, assuming all other factors are positive.
Sometimes, there is a gotcha in the terms.
Potentially the terms could be not quite right. This happened once where the voting rights were not favorable to the Preferred Series Angel round. I caught this at the eleventh hour and thankfully the entrepreneur agreed to a change in the docs to make this more favorable. Otherwise, our terms and rights could have been wiped out without us having any say in it! You always need to review the terms no matter what and I would do it with a seasoned lawyer who has done many financings before, and hopefully from the perspective of company and investor.
Caveat Emptor – “Let the Buyer Beware” – words to live by and in the investing world you have to dig into every little detail in every deal. It costs more in time and money, but it keeps me out of trouble.

Convertible Notes versus Preferred Equity, Part II: Enterpreneurs

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In reading my last post, one may start to think on why either method may be more or less desirable to an entrepreneur seeking to raise cash.
Why a Note?
It is Cheap.
Early stage startups typically have little cash to spend. Closing a Note allows them to bring in money in the cheapest possible way. Preferred Equity will cost them 10 to 20 times more.
It is Fast
Often startups need cash as fast as possible to fund short term operations. A Note closing can be accomplished in as little as two days.
It is Unsecured
For early stage startups, every Note I’ve seen has been unsecured. If the company goes under, there is no obligation to pay the Note holders back. It could be secured by assets, but generally for early stage startups it is not. Why would you get paid back with 1/10 of a PC?
Maximum Flexibility
In the case of early stage startups, we talk most often about a Convertible Note which Note holders want to convert to some version of stock in the company. Depending on how vague the language of conversion is, a startup could convert the Note holders to common stock, to Preferred Equity, or even to the terms of another Note. There is the potential for maximum flexibility on the part of the company as, in theory, it could convert to anything if they word it right. Another aspect of flexibility comes in next financings. For instance, with a Note, valuation for the company has not been set yet so there is freedom to adjust. It also means there are no preferred shareholders and could be more attractive to certain large investors who want more control in the company.
It is Low risk
The Note holder often has an interest in helping the company and getting in on the ground floor, and they can be generous with the payback period and the terms. Assuming the company either gets to a place of generating money or raising more, a Note of this type can be paid off prior to the due date, or converted to preferred in the financing, in which case the Note turns into equity and expunges the debt.
Why not a Note?
Not many reasons to not use a Note first, from the company perspective.
It misaligns helpful investors with the company.
The startup may have some investors whose contacts you want to leverage, or who are actively giving you help. By executing a Note, the startup creates a situation where the investor is not incentivized to help the company. If the company grows in value, and since Note holders don’t have actual ownership in the company yet, then Note holders gain smaller share of the company when the Note converts. Helpful Note holders want to help, but they will see their potential stake in the company if they help drive the valuation of the company upwards.
But read on for some thoughts on Preferred Equity.
Why Preferred Equity?
It aligns the interests of helpful early stage investors with the company.
In Josh Kopelman’s blog post about Bridge Loans vs. Preferred Equity, he explains it well. Once investors jump into a preferred series where they have actual ownership in the company and feel good about building value with the company, as their own value in the company increases with whatever value they build.
It rewards early stage investors with their support of the company.
Early stage investors have the riskiest position. They go invest in a company early, and often they get their stakes diluted by subsequent investments until they get nothing back. This seems grossly unfair for people who supported the entrepreneur at such an early time when there is barely no clear value built yet. With a preferred series raised with the earliest investors, they are rewarded for giving their support early on and the preferred equity will most likely resist dilution with the proper provisions.
It attracts investors.
Like with the previous item, preferred series are just more attractive to investors simply because you gain immediate ownership of the company and not have to deal with potential uncertainty of Convertible Notes. Entrepreneurs can increase their chances of getting more investment by offering this early on. Many investors are gunshy of Convertible Notes and want ownership immediately.
Why not Preferred Equity?
It’s expensive in time and money.
You spend more money executing the paperwork, and there is a lot more paperwork to do. This may be too much for an early stage startup to bear financially.
It could deter future investors.
Venture funds don’t like to have others in potential control of the company. They want it all. Other preferred shareholders could present a problem here as they may have preferential voting rights, perhaps even a board seat. Also, preferred equity terms often have anti-dilution provisions which prevent future financings from grabbing a larger stake in the company.
Operationally, it adds a bit more complexity.
Now a preferred shareholder elected board member may be present, so there may be another voice in the operations of the company. Potentially, other large directional moves by the company may require the preferred shareholders to agree via vote.
Still not an exhaustive list, but some thoughts I’ve picked up along the way. More interesting thoughts in Part III from the investor point of view, coming up next!

Convertible Notes versus Preferred Equity, Part 1.5

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Oh one other quick word.
When I started dealing with term sheets in both Notes and Preferred Equity, I strove for understanding. I went in thinking that this was an orderly process and that there were standard contracts for this sort of thing.
The one thing I learned is that NOTHING IS STANDARD.
Terms are written purely on whatever the entrepreneur and the investor(s) want. Yes, there are standard things like interest rate payments or anti-dilution provisions, but as for what interest rate to pay or which type of anti-dilution provision of which there are many…all up for grabs.
So if anyone tells you their term sheet is standard in the industry, don’t believe them. Everything is negotiable, so just say, “Thanks I’ll take a look and get back to you.”
Onwards to Part II…

Convertible Notes versus Preferred Equity, Part I

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Just recently the issue of Convertible Notes vs. Preferred Equity came up with an entrepreneur. It was an interesting discussion and caused me to think deeply about both types of financing methods and why entrepreneurs and investors may or may not like either one.
In this Part I post, I describe what I’ve learned about Notes and Preferred Equity. This is by no means exhaustive or even showing that I’m an expert in this, but I choose to state what interesting information I did dig up over the many months I’ve been doing this angel investing stuff.
Characteristics of Notes:
1. They are cheap. I just heard a quote from a law firm that, after terms were set, you could close a Note at about $1000 in legal fees.
2. They are quick. You can close a Note in about 2 days, assuming everybody gets their cash transferred in. If you need cash in a hurry and the other larger financing round is going to take more time to close, then the Note can give you cash in the short term very quickly.
3. The paperwork is minimal. Only one document is required, which is expanded from the term sheet and spells out the terms of the Note in exhaustive detail. Investors sign that, the money is transferred, and you’ve got cash.
4. At early stage, many companies have little assets. Generally, for early stage startups, Notes are unsecured, meaning they are not backed by the assets of the company. So if you go under, you are really under no obligation to pay investors back.
5. It keeps options open for the next equity financing. Valuations may change and the Note doesn’t cause any potential issues with Preferred Equity ownership prior to the next round of financing.
6. Negotiation on terms is possible, increasing time and cost to close.
7. Notes, or convertible notes, are basically loans to the company. The investor doesn’t own any part of the company, and there is a promise to pay back the loan with interest. The convertible aspect means that at some point, generally when the next financing occurs, the money you invest would convert to the terms of the next financing. Sometimes it’s spelled out as to which financing it is, and sometimes it is not.
Characteristics of Preferred Equity:
1. Preferred equity holders gain actual ownership in the company.
2. It locks in a valuation for the company at time of closing.
3. They are more expensive than Notes to close. A recent quote, after terms were set, would cost about $10,000 to $20,000 in legal fees to close a Preferred round (versus the $1000 of a Note closing).
4. Preferred Equity rounds take longer to close. They may take up to 3 weeks to finalize everything (versus as little as two days for a Note).
5. There is more paperwork involved. A Note involves only the expanded Note document. A Preferred Equity round involves a Stock Purchase Agreement, Investor Rights Agreement, filing of changes in the Articles or Certificate of Incorporation, potentially a Voting Agreement, and other supporting documents and changes. After all the paperwork is signed, a Preferred Stock certificate is sent to each shareholder.
6. It will require an official board meeting resolution to approve, and recording of minutes.
7. Negotiation in terms is possible, increasing time and cost to close.
8. Preferred Equity may cause issues in further financing rounds as follow-on round investors may desire more ownership and/or control in a company and may be deterred from investing by the fact that there already are Preferred Equity owners present.
9. Preferred Equity holders get preferential treatment as defined by terms. These can be things like, in case of company liquidation, they get paid back first, or anti-dilution provisions, or special voting privileges, or the ability to select a board member to represent their interests.
In Part II, I look at Notes versus Preferred Equity from the entrepreneur point of view. Part III will look at Notes versus Preferred Equity from an investor point of view.

The First Investor Meetings!

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A potentially scary moment is when you get into your first investor presentations. One of my startups is doing that right now. So before the meetings, I tend to send lots of comments to prepare them. Here are some of them:
1. You will be presenting a term sheet. Most VCs will present their own and I am sure it will be investor friendly. See item 2 below.
2. VCs may tempt you by closing quickly and shoving a term sheet in your face, hoping that the positivity and amount of money will sway you into signing right now to get the money. See item 3 and 4 below. My advice is to never sign anything especially in the emotional euphoria of a positive meeting. I would shop around first and make them compete against each other if possible on terms.
3. Always be ready to say ‘Let me think about it.’ Don’t accept anything too quickly.
4. Don’t let desperation cloud judgment. Ever. And it’s corollary (see item 2 above), don’t let euphoria cloud your judgment either!
5. There may come the option to skip the note if a VC you like wants to close quickly. Be ready to address this as an option, and hopefully a positive result for both you, the VCs, and us angels. By positive I mean that we all invest in and get stakes in the series A. Negative results would mean us angels may get squeezed out.
6. Make the note close between 250K and 400K. Keep the option open to close sooner if you think it’s a good idea, or to extend fund raising to grab the extra 150k for a total of 400k. Don’t just close on 250k if you think you’ve got it. You may be able to get the full 400k if you work a little harder and a little more time. Remember item 3 above.
7. VCs may want part of the note. Especially if you’re giving a discount. They may demand to write into the note the right of first refusal to invest in the series A of some percentage. I would recommend not letting them do the full amount, but say up to some percentage like 50%.
8. VCs may attempt to squeeze us angels out to gain a higher percentage of ownership of the company. Being an angel, I will only ask that you do not let this happen for our sake.
9. VCs may demand a board seat. This is probably ok, but make sure you select the board member VERY CAREFULLY. You should get along with this person, like them, and want to work with them. Getting rid of a board member is not like firing an employee. You will be stuck with this person for a long time. Choose carefully and wisely.
10. VCs will undoubtedly ask for a huge percentage of the company. I would only say that a smart VC should never un-incentivize an entrepreneur by taking huge stakes in the company and dropping the entrepreneurs ownership to near nothing. It’s a dumb move and unnecessary. I would say you could get away with 25-40% depending on the situation.
11. VCs may like the idea so much they want to give you more money. Be also very careful of taking too much money. It will affect valuations, ownership percentages, and also exit strategies. Now venture funds are huge with cash; they want to deploy more whenever possible. Don’t let them tempt you into taking too much!
Other stuff:
1. Be prepared for the due diligence process. It involves getting a huge amount of paperwork delivered to potential investors. Get it all organized and ready to go now, and thankfully you haven’t been in operation very long or else the paperwork could be immense.
It’s always an exciting process to present your ideas and business to potential investors. It is unfortunate that there are so many sharks out there and trying to not get eaten is the name of the game.

Guardian Angel

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The other week one of my entrepreneurs jokingly referred to me not just as an angel (as in angel investor) but as a guardian angel. I laughed.
But it’s also got some real serious undertones.
The more I meet entrepreneurs, the more I realize that there are real BIG holes in their knowledge. This is even more apparent with first time entrepreneurs. Even I had big holes in my knowledge base regarding investing and startups when I started David Shen Ventures, LLC.
How did I learn? I tried to find people to sit with me and talk with me. But so many of them are all busy and I also found out that a coffee or lunch is just not enough time to go through everything and have it sink in. I tried looking for books, but many were too generic to be useful. I did find a series of really expensive books on venture funds but they were very complex to read and took a while to figure out what they were talking about.
I eventually paid my lawyer for about 1.5 hours to sit down with me and go through some example financing docs. I made notes on these complex term sheets and other paperwork and then I could go back later and review what I had heard and written down. One funny thing was that when I met with my lawyer, he actually brought on another lawyer whom he partners with in financial deals. He was probably the most conservative, worst-case-scenario lawyer I had ever met; I almost quailed at giving my money to anyone after talking to him! But I also learned that early stage startup investing is not for the risk averse and that you can’t get the same security as for other more established companies in later stages. Still, that 1.5 hours was not enough time to let everything sink in, but I had a better base to draw from.
Then I started reading some blogs about venture funds. I especially like Josh Kopelman’s blog and I find his posts about investing in general to be really informative. This brought more knowledge in but still didn’t complete the picture.
It was when I started doing a few angel investments when I really started to hit my stride. Arguing for terms was one of the best ways to firm up in my mind what risks there were in a particular deal. So many details all intertwined: valuation now and in the future to achieve a given return, percentage company owned, future return, squash prevention (or preventing dilution), notes versus preferred series. I always carry a calculator with big buttons with me at all times to punch in numbers and make sure my mental calculations are correct. I am getting more and more proficient and arguing from at least the point of view of a knowledgeable angel investor.
Now think about the new entrepreneur. Not much cash. No exposure to the financing world for the first-timers. I was willing to pay for some of my education with my lawyer (I just thought of it as educational expense) but others can’t afford that. So what do they do? Where do they find help?
As advisor, I feel compelled to help them. And I don’t mind as many meetings as it takes to get them educated. With this particular entrepreneur, I have had meetings weekly, many email exchanges, and also sat in with them on presentations. We talk about everything. The presentation, what to talk about, financing strategies, the usual company strategy stuff that I advise on (product, user experience, advertising, etc.), everything.
Before presentations, I email them for things to watch out for, and remind them to mention this and that. Post-meeting I email them again and give them one person’s objective view on how it went. We go over the financing strategy and explain to them some of the details that are hard to understand if you haven’t done it yet. I give them strategic advice on the pros and cons of doing financing one way or another, and how investors will react to certain terms. I give them example term sheets and show them what terms can look like, and what investors like and don’t like and why.
I make myself available to them because I know there is no one else that is willing to spend that much time with them. And while I give them information, I try not to make the decisions for them; I make sure they have as much information as possible so they can make an informed decision and not one that has blind spots.
So from angel (investor), I became guardian angel. I keep them out of trouble as much as possible and in many cases I’m the only guy doing it.
How ridiculous is that. In our world, we seem to have major problems finding mentors who will give their time and expertise to others. If you don’t have the connections and relations, then it gets even that much harder to find someone who is willing to help you. I for one hope to change that with my entrepreneurs. It is my belief that whatever knowledge I give them will give them a greater advantage over other companies who are still in the dark.

On Being an Advisor

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When I talk to entrepreneurs about working with them, I make it a point of saying that my business is based on the assumption that they will have a better of chance of success if I am actively helping them versus if I’m not. Therefore, if I invest in a company, I require them to make me an advisor. And yes, it’s also a form of investment protection for me since I’m watching over my money by being involved.
One might think that if I were to invest, that the advisorship wasn’t necessary. I would be tied to the company through the investment and the ownership that comes with it, and probably care greatly about the company’s progress and help when I can. In some sense it’s true.
But I have already come across cases where even though people SAY they want my help, they really don’t. They just want my money. One way to test that, besides watching my intuition about these things closely, is to see if they will sign me up as advisor.
When they do that, they need to be willing to compensate me for the advisorship. Since I deal with early stage internet companies, often pre-funding, I told myself long ago that I would not ask for cash payment like a consultant. Many people who do what I do will ask for consultant hourly fees to work with a company as an advisor. But I cannot. An early stage startup barely has cash already; to drain them of whatever little savings they may have could cripple or destroy the company. I would rather that they take that cash and build the business. In fact, I don’t think they would sign me up if I were to ask for cash. So I ask for options to equity, vesting over my term which is typically between a year to two years.
If they are willing to give up some of their options pool for me, then that is definitely a good sign that they are actively seeking my help since they are giving up some form of payment to me. It’s not 100% reliable, but there is nothing better than seeing a company give up something like cash or equity to ensure their engagement in you; they’re giving up valuable options that they could give to someone else like an employee, but instead they are giving it to me, so they better utilize me and get their money’s worth!
Being an advisor also clarifies my involvement in the eyes of outside world and within the company. I don’t want to be perceived as a bothersome investor, who keeps sticking his nose into the company’s business. With me, I’d be bugging people about product strategy, the user experience, and online advertising all day long. Without a statement of purpose like “David Shen is our advisor and he will help us in X, Y, and Z”, it becomes that much harder to communicate and reinforce why I’m hanging out with the company. I believe with that clarity comes acceptance that my advice will be given, and that they should listen. If they aren’t ok with that, then issues would come up during the advisor signup process in which case maybe it wouldn’t make sense for me to get involved with the company, if they don’t perceive my help as valuable. By the way, this has happened already.
It also clarifies in my mind what I’m supposed to do every week. If I’m signed up as advisor, I have an obligation to help them since I want to earn my options. If my term is over, then I can mentally shift and focus on the other companies whose terms are still on-going.
So is my help going to continue after the term? This part is still a bit undefined since my business is so new. A few thoughts on this:
If I’m an investor, I’ll always be around until I exit the investment. To what extent I am involved depends on the state of the company at the time of end of my advisor term.
I always tell people that by the end of my term, my goal is to teach you everything I know, help you get people in place to permanently take on what I have brought to the table, and bring on any relationships you need through my network. Generally, I think one year terms are too short to do this, but 2 years is a bit beyond the point of finishing this task. So somewhere between 1 to 2 years is where I think I’ll accomplish those goals (it’s very uncommon to do 1.5 year terms even if I think it fits my mental timeline of when I’ll finish my goals). For that reason I like 2 year terms better than 1 year, or else I think that the chance of not accomplishing those goals is high and if my advisorship does not get renewed for another year, then I’ll feel like my job with them is unfinished. So theoretically, if I do accomplish all that, then you’ll have people and relationships in place to do everything I helped you with, and only need minimal involvement from me post-advisor term.
I believe that when people see what value I have brought to them during my advisor term, that they will keep me engaged after my term ends. But I can’t keep shepherding them in their tasks; they need to be able to function effectively by themselves since I’m not an employee. And thus it’s critical that they hire great people who can do all the things I helped them with, and I will be helping with that aspect as well.
However, if they really want to lock-in my involvement post-advisor term, they should renew my advsior contract and we’ll keep going officially.
So far, being an advisor has been a rewarding experience. As I do my work, I am pretty active and aggressive at checking in and seeing opportunities and throwing ideas over to the entrepreneurs. I have found that they have really appreciated it. Anecdotely, I am finding that I am outpacing most, if not all, of the other advisors that they have brought on. I find this to be an interesting revelation. It seems to me that traditionally most advisors are only called upon very sparingly. Perhaps it’s because I’m an investor in some of these companies that I care more and want them to succeed; but I also am pretty regular in checking in with companies which are quiet at the moment.
Because of my seemingly extra effort, some of them have offered to find some way to thank me beyond what compensation we’ve agreed on. While I appreciate it, I do not expect it. The satisfaction I get in helping these entrepreneurs, seeing my help get them to success, getting caught up their energy and excitement for their company and product, being a part of the celebrations of closing their series A funding or their first $1 MM of revenue – it’s ample reward to know that I am part of that and that my help is being actively utilized, appreciated, and validation that my help is worth it.

Leaping into the Angel Funding Process

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Three of the companies I’m working with are now approaching the fund raising process. Often with these entrepreneurs, there is a lack of exposure and experience to how the investor process works. Here is an (edited) excerpt from an email exchange regarding some details and expectations from the fund raising process, and about an upcoming meeting with a prominent angel investor:
I’m glad I broached the subject. Thanks for the detailed and insightful response, Dave.
DSHEN: I consider it my job as advisor to teach you as much as possible and get you up the curve as fast as possible to set your expectations correctly, to prepare you for the best and the worst, but also to have a really fun time at all this ;-).
What’s a likely scenario in your mind?
* Send term sheet and 1-pager immediately
DSHEN: I think this is a good idea. It will help keep the mtg shorter and you and he can focus on his real questions.
* Meeting on Thursday
DSHEN: Present your deck, field his questions, pray for positivity.
* How many more meetings until we close a deal?
DSHEN: No idea. It will vary from investor to investor. Generally if you have a group of investors, you’ll get a general “I’m in” and you should add them to your list. You’ll always have to check back with people to make sure they are still “in”. Sometimes they may drop out. This motivates you to close funding as soon as possible.
By close funding, I mean:
– accelerate as much as possible meetings with investors. Do not sit around not fund raising, even if you have a lot to do. I suspect that the burden will fall on your US person to do the fund raising since she is here in the US. It will be really tough. You’ll have other commitments and try to field them, but if you don’t go as fast as possible, this will drag on for months. The longer you wait to close, the higher the possibility that somebody might drop out, thereby lengthening the process even further.
– set a date for yourself to close by. Set a monetary minimum and maximum goal. Setting a minimum both mentally and financially will mean you will be faster in deciding whether you want to stop fund raising, close the funding and collect the funds and finish the massive amount of paperwork, and get back to work. BTW, in a good scenario, you may actually have more investors wanting to give you money than your maximum and may want to decide to take that. This is actually a harder decision than it looks, as it affects valuation and how much of the company is sold to investors.
– the closing process is one of document preparation. You’ll get your lawyer to expand upon the term sheet into the relevant docs. Since you’re doing a preferred angel round, you’ll need a stock purchase agreement, an investor rights agreement, and some others. You’ll also need to change the articles of incorporation.
– the closing process is one of gathering signatures. Like herding cats, you’ll need to help get all the signatures back to Monty. I would recommend getting an eFax account. It will help you electronically pass around faxed signature pages versus shuffling paper. I have one and love it as all incoming faxes get emailed to me as PDFs. (by the way, it works great also as a document scanner; you just throw the doc into a fax machine and fax it to yourself).
– the closing process is one of collecting money. You’ll be surprised at how hard this process can be. Usually, your law firm will setup an escrow account where the money will go to first. This is to prevent you for going to the Cayman Islands with our money if we were to send it directly to your bank account (haha). Once the money is collected, he’ll run all the docs, get all the signatures, get everything filed, and then the money goes into your bank account.
– after all this is done, you’ll send back to everyone their copy of the signature pages. Your law firm might prepare a nice notebook with all the docs in it, or not. You may want to pay for that or maybe it’s part of the package.
And lastly, we get our nice Preferred Stock certificate in the mail from your law firm a few weeks later.
* Dave, it is my understanding that if this investor is in, you’re likely to close as well?
DSHEN: Actually my commitment to you is not dependent on that. I have already said that I would invest and now it’s a question of exactly how much I will put in, and a final review of terms. Also, I will need the advisor agreement signed with you since that’s how I operate, which is I require that I be an active participant (advisor) with any firm that I invest in, on the assumption that my help will raise your chances of success than without my help, thereby somewhat protecting my investment.
BTW, you’ll find that some investors won’t invest unless somebody else goes in too. A lot of people go on the opinions of others, especially those who aren’t as good at evaluating companies in the internet space. Some won’t go in unless you reach a certain threshold of dollars committed, also as a way to gauge others’ confidence in you. Be prepared to deal with this in your fund raising travels.
* Would we close with just you two, or would we have to wait for other investors to come on board as well?
DSHEN: Most likely with a dollar amount of $1MM, you’ll have to have other investors at the angel level. Unless you find someone who LOVES you and what you’re working on, AND they are richer than you or I can imagine (there are a few people like that in the valley). You already have a small list of people who have verbally committed; ask your partner about that and I believe I am already in that list.
I understand that these things are not entirely predictable, but we still need to have a clear plan, with milestones and tasks, so we know what we’re aiming a and so we can track progress and change our strategy when things don’t go as expected, and so we can plan for our finances in the meantime.
DSHEN: Yes, hence my comment on setting a closing date. You should be doing regular check-ins, on progress and keeping a list of investors (ie. Contact info and contact progress (ie. Sent term sheet, no response, got warm response, referred me to his buddy, etc.), amount committed or not, did they refer you to someone else so you can thank them later, how did the mtg go?, were they assholes or not :-), etc.)
The fund raising process is going to double your workload, maybe even more.
Be prepared for sleepless nights for a long time, a lot of frustration at not returned calls/emails, watching the process go super slow, etc. And then be pleasantly surprised if you are able to close early :-).
Last word on this fine cold NYC morning: find investors who are going to help you if you can. Taking non-helpful money is OK, but not as nice as getting someone involved in your company who has skin in your game and can also help your business, like leveraging their list of contacts. Sort of like when I invest, I am doubly motivated to help you than if I’m just an advisor.
Some other notes about investors:
We’re dealing with a large sum of money. $10K, $50K, etc. are especially large sums of money for angel investors. You’ll find that money changes people and there will be some people that will say they will give it to you and then pull out at the last moment. It’s frustrating and you’ll wish that people mean what they say, but be prepared to encounter some who won’t be able to part with their cash, even if they insist that it will show up tomorrow.
If a few pull out, this could mean that you won’t be able to close and you’ll have to go back out and raise more money.
Keep the number of investors as low as possible. There will be people who can’t stop bugging you about how their money is doing. This is also related to the previous point; this sum of money is a large amount of money and there will be people who will be overly paranoid about losing it. Experienced angels won’t act like this since they’ve done this before, but the likelihood of it happening with unexperienced angels is fairly high. So keep the number of investors low; it will reduce the chance of this happening and reduce the chance of added distractions in keeping investors happy.
The fund raising process can be filled with frustration, consumer incredible amounts of time, and be extremely rewarding building your confidence and your rolodex with each meeting. Have a positive attitude through the whole process, don’t give up, and have a great time with it.

Don’t Need to be Lead Investor to Affect Terms?

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As I started angel investing into startups, I began realizing that the amount I was investing gave me virtually no leverage to affect terms. The largest investor typically has the most power to affect terms, since the entrepreneur wants their money the most. They are more likely to negotiate and do what that investor wants than other small fry…like me.
One goal I have is to take the cash I set aside now and try to build it over the next few years to a point where I could be lead investor and really affect terms. This usually starts happening at around a $250,000 or more investment.
But I did find one place where I could actually affect terms without requiring large sums of money. First, I asked my lawyer to draft an example Series A term sheet. I also asked him to make the terms balanced towards investor and the company. This was an important point; many times now, I have seen investments go much quicker when the terms were more balanced. This is even true with my advisor agreement, which is neither overly advantageous towards me or the company. It reduces negotiation, and thus legal fees and time – both of which are desirable.
Second, I start advising these companies very early, even pre-incorporation. I help them in the process of defining their fund raising strategy, and give them my sample Series A term sheet. They love that. Otherwise, they would have to get it from their lawyer and that would cost extra cash. Instead, they present that to their lawyer who reviews it and is usually agreeable on basing their actual term sheet off mine. it would cost them extra cash to alter it later to the requests of potential investors, as well as costing money to go over it with their legal help to understand it all.
This is good because now I have a fair, balanced term sheet which I am investing in, rather than something created by the legal support. Given that most entrepreneurs are new to the fund aspect, and the fact that lawyers will most likely default to a company friendly term sheet to protect their client, being aggressive at presenting a sample term sheet which is balanced provides an opportunity to create a situation where I can actually affect terms and not be the lead investor.

The Legends are True! Raising Funds on Powerpoints

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Well, I finally saw it myself. Two friends of mine just raised venture capital for their startups on…a POWERPOINT.
Before this time, it was by rumor that I heard people were walking in with ideas and getting funding. No company, no corporation, no IP, no technology…nuthin! But getting $1MM to $4MM committed. And the rest of the world struggled along with their business plans and prototypes…
I tried to quantify what made these two people unique. Here are some thoughts:
1. They are both very persuasive presenters. Very good at pitching their ideas.
2. They were well-known to the venture fund. Both people had fund partners begging them to start something…anything…so they could fund it.
3. They had decent track records.
4. Both had high integrity, so trust is a factor. They were also very realistic about their prospects and didn’t oversell or overcommit.
5. Both could attract talent amazingly well. While everyone else was struggling to hire, these two got committed employees with no company existing! So they were well-known and trusted to the people they got on board.
6. Of course their ideas were pretty damn good too. They were presented as very well thought out ideas and with an answer for all tough questions.
Sorry Microsoft, but I don’t think Powerpoint had anything to do with their success. Too bad if that was all someone needed was advanced presentation software to get funding…!