Structuring an Angel Round
If you decide to raise investor capital to fuel your startup, a common first step is raising seed funding from angel investors. Here are a few hard-earned observations and tips from my experiences raising millions in angel capital across several different startups.
Every round of financing has its unique dimensions. Yet, some patterns can prove helpful to keep in mind when planning an angel round (good background to consider alongside this post are my previous posts Fundraising Differences Between Angels and VCs, Qualifying Angel Investors, and Maybe You Haven’t Asked Enough People Yet):
Pick an Appropriate Angel Round Size
My personal experience, which is primarily in the healthcare, renewable energy, and tech spaces, is that a realistic expectation for an angel round is $750K to $3M, depending on the stage of the startup’s development and the background of the CEO.
Sometimes when I am talking to new entrepreneurial teams, they are seeking to raise $100K or $250K. This is often too little to make enough progress and starts the team on a shoestring road that can lead to lots of little raises that create capitalization table complexity (see below). Generally speaking, if you are going to go to the effort and risk of raising capital, I think you should be raising a minimum of $750K to justify the legal and time investment and to ensure your startup has enough runway to actually build enough to move the valuation needle.
On the other end of the spectrum, in my experience, $2-$3M is a pretty big angel round unless you happen to get connected to some super-angels. Pushing much beyond that as a goal seems to result in a pretty steep drop in interest as many angels conclude that the round is “too big” for them to fund or some other such logic. If a team tells me they are trying to raise $5M from angels in one go, I will often suggest breaking the round into two smaller rounds and ensuring that there are substantive milestones associated with each. This may mean doing some careful thinking about how to be more capital efficient in achieving important de-risking milestones.
Defer Angel Round Valuation
Usually, an angel round is a stepping stone to raising bigger boluses of capital, often from venture capital firms. Raising at very early stages is tricky because there usually is not enough value built to justify a substantive valuation, and founding teams do not want to give up 80% of their company right out of the gate.
When raising angel capital with the expectation of eventually raising venture capital, structure your angel rounds to be a future VC-friendly as possible by deferring “pricing the round” (setting a valuation) until later. That often means using convertible notes so that angels are not forced to price your round and then get crunched when the VCs come in later. This protects both the angel investors and increases the likelihood that you can raise that VC-led round without killer valuation questions emerging that make it hard to get your existing investors to approve the capital raise (which they will usually be required to do.) Do not underestimate the risk here. I nearly had one of my companies die on this particular hill when some of the angels did not want to accept a down round.
Beware Term Sheet Complexity
Sometimes creative angel investors want to introduce all sorts of nuances into the terms of an angel round. This is a disastrous way to start the capitalization table of a company. Those terms in those very first rounds create expectations for terms in future rounds. For example, if an earlier round demands a 2x liquidation preference, there will be pressure in future rounds to match that term. Use a highly experienced attorney who is familiar with current norms in term sheets and push back to avoid introducing complexity at this stage. Your goal is to be as boring and plain vanilla in your terms as possible so that potential investors find your existing investment terms to be well within the norms. The best argument to use is often that you are seeking to reduce future financing risk for the company, which is a goal that the management team and the angel investors should be able to align on.
Minimize Capitalization Table Complexity
Bear in mind that many VCs are cautious about the complexities in the capitalization table that can occur when many angels have invested. For example, I have had multiple startups where I raised from 50 or more angels over the course of several rounds. This does end up being a conversation point for some VC investors. Mitigate this risk by being organized, maintaining excellent communication with your angels so they are prepared to participate well in future rounds, and do your best to respect and take care of your angels to minimize troubles later on. When possible, take advantage of opportunities to bundle angels into LLCs or other vehicles to reduce the number of approvals needed to take corporate actions. Make sure those organizational vehicles are led by sophisticated angels who can partner well with the VCs. All of this can establish a good base to grow on.
Board of Directors
As I have written about, there can be great value for startups in having an outside, investor-led Board of Directors. However, remember that ultimately you want to keep your Board of Directors lean and agile. That means that while it may make great sense to add several of your leading angels who have relevant skills to your Board of Directors, you should also manage expectations that there may be a time when you replace them with other investors on the Board. Later investors may require a restructuring of the Board of Directors as a condition of their investment. This can mean that the number of Board seats available for angel representatives gets winnowed down as the company grows. If you manage expectations well from the beginning, this can be handled with grace and maturity. If not, you can find yourself with some unhappy investors who feel betrayed when asked to step aside later to keep the Board evolving alongside the capitalization table.
Set Expectations for Future Investment Opportunities for Angels
Remember that once big VCs are invested in your company, you usually only raise additional angel capital from the angels already in prior rounds rather than add new angels. Once the company shows momentum, there is seldom room in future funding rounds for adding new angel investors. The bigger VC investors will generally prefer to keep the number of investors in a VC-led round smaller while respecting the angels already invested in the company. Be careful not to make promises you cannot keep as it may not be a choice you can make to let an angel in later since a lead VC can have a controlling opinion on that subject.
When raising angel capital, I try to manage expectations by taking opportunities to ensure that angels who are thinking of waiting for a future round know that there is a risk there may not be an opportunity to participate later, so there are no hard feelings if that comes to pass. For example, at Fifth Eye, we only raised one round of angel-level investment. I knew that our strategy and likely path would engage major VCs for the next round, so I made sure that those who were passing on the first round in hopes of joining later knew that there was a good chance that opportunity would not be available. I got several phone calls when I raised our Series A asking to participate from individual angels and angel groups that had chosen to wait. I respectfully said, “I am sorry, but that opportunity is no longer available.” Maybe next time they will believe me.
When raising capital from angel investors, be sure to think ahead to seek to avoid creating situations that will make further fundraising difficult. Your theme should be to keep things as simple as possible so that you minimize hurdles you will have to overcome later on in your startup’s fundraising.
