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  • Writer's pictureLumus Investment Collective

What to keep in mind when making your first angel investment

There’s a number of choices you’ll have to make as an angel investor that will have a huge impact down the road. Our amazing legal partner Eldison has summarised it for you.

Need for speed: equity vs. convertible loan

Convertible loan rounds can be closed in a matter of days while equity rounds typically take weeks at minimum. So if you’re looking to cement a deal as soon as possible, convertible loans are your instrument of choice.

Is the equity round far from sight? Don’t forget about interest

If the founders are not planning a qualified round anytime soon, it might make a lot of economic sense to negotiate a reasonable interest rate. When the time comes to convert your loan into equity, the loan amount will include any potential accrued interest and you might get more shares for your buck.

Advocate for an ESOP pool

Ideally, you want an ESOP pool to be created before you make your investment to avoid dilution. Pragmatism aside, a functioning ESOP will help the founders attract top talent and make the company a success, so it’s always a win-win.

Nail down the conversion mechanism

Make sure that the conversion conditions are fair and crystal clear to both you and the founders. In terms of the valuation, you want to aim for a combination of a valuation cap and a valuation discount because it will help you protect your investment against soaring valuations.

Protect yourself against future dilution

There’s two things you will definitely want to see in your term sheet: a pro-rata pre-emption right and an anti-dilution right. A pre-emption right will make sure you can buy more equity in the future. Anti-dilution right protects you against down-rounds by obliging the founders to issue new shares to you. Aim for both.

Dream big: negotiating for an exit

Exit is the proverbial light at the end of the tunnel. You can get ready for it by negotiating a solid liquidation preference. The market standard is a 1x non-participating preference but if you’re feeling more aggressive, you can push for a higher multiple or at least a liquidation preference with accrued interest.

Some handy legal vocabulary 👇

Convertible loan: a loan that either converts into equity (typical scenario), or is repaid

Equity (qualified) round: an investment round in which investors get stock in the company

Dilution: the decrease in existing shareholders' ownership percentage as a result of the company issuing new shares

ESOP: Employee stock ownership plan lets employees of a company own shares (or other assets) of the company

Liquidation preference: the preferred right to repayment of the investment amount in case of liquidation event (typically exit)

Term sheet: defines the most important terms and conditions of an investment

Valuation cap: valuation cap sets the maximum price for which a convertible loan will convert into equity

Valuation Discount: a discount (in %) on the equity round valuation (e.g. 20 % discount on a 20 million round means that a loan will convert at 16 million valuation)

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