If you are trying to raise finance for your business, angel investment is an option that you should consider.
Previously, we have spoken a lot about finding investors, including angels, and attracting them to your business. However, once you successfully get to this point of convincing them to fund your company, you need to structure a deal that brings benefits for both sides.
This guide explains how an angel investment deal is typically structured and the choices your business has during the process.
- Equity stakes
- Convertible loan notes
- Create a term sheet
- Be diligent
- Prepare for negotiation
- Move forward
Equity stakes
Any deal with an angel investor will invariably involve an exchange of equity, share in your company, in exchange for their investment. This equity will generally be at similar rights to your own shares e.g. pro-rata share of any dividend, etc.
The amount of equity you grant to the investor will vary, depending on the business valuation that you have already agreed on. This also likely determine how much funding the investor is providing you. For example, if your company is valued at a million pounds, and the investor gives you £100,000 in funding, they would expect a 10% equity stake.
This is a simplistic example, as it is possible to issue different classes of stock in your business, which will affect the investor’s entitlements. These could include different voting rights (which influence business decisions) or those who receive their dividends as a priority. This may cause the value of stocks to differentiate, at which point it makes sense to bring in a lawyer to help you understand the implications and find a deal that suits all parties.
Convertible loan notes
While most deals begin with an equity stake, there are instances where the investor and business may be unable to agree on the company valuation at the time of negotiations. This is where a convertible note comes in.
A convertible loan note allows both parties to determine the company’s value at a later date (usually when it has matured slightly or attracted more funding). It is set up as a loan to the company. If the investor puts in £100,000, this would mature at a specific date in the future and gain interest. At the time of the maturing, the investor can either ask to be repaid (covering the initial loan plus interest) or convert the owed balance into an equity stake, based on the company’s valuation at that time.
Convertible loan notes have become more popular as they enable entrepreneurs and investors to maximise investment rather than pinning activity on a time-specific valuation. If the company valuation excels in the timeline given by the note, the investor knows they are working with a high-reward company and can choose to switch to equity. At the same time, the business only has to give up a smaller equity stake in their business.
Create a term sheet
Once you have determined the structure and value of the deal, it’s time to set the terms between each party. A term sheet is a non-binding document that sets out the conditions of an agreement while giving the business and investor a chance to negotiate or feedback on any issues.
Aspects to include in the term sheet include:
- What entitlements the investor will have – including voting rights and share class
- Stake percentages
- The company valuation used for the deal
- Timeframes
- Liquidation preferences
- Any criteria your company must meet as a funding requisite
You will also want to include information about the investor’s exit from the company – including what will happen if an investor wants to sell their shares or the company founders decide to move on.
This will create the blueprint for the relationship moving forward and take a step towards a formal deal between you and the investor.
Be diligent
When structuring a deal between your business and any angel investors, it is essential to be diligent and cautious throughout the process. This means making sure that everything is accounted for in the agreement and documented in the accompanying paperwork.
The benefit of taking a careful approach like this is that it ensures consistency and clarity across the deal while leaving no room for miscommunication or confusion. It will also enable both sides to manage expectations meaning that, once the deal has been agreed, all parties are aware of what they must do to stick to their promises.
It’s also worth recording any updates that may occur during the deal process, including revisions that have been added at the request of either party or changes to the company to give complete insight.
Prepare for negotiation
Once a term sheet has been circulated, it is an opportunity for either side to negotiate. This will be where the final deal takes shape.
During the negotiation stage, both parties will likely be pushing for their wants and priorities, but there must be a meeting point where all leave with a fair deal. It may take work to reach this stage.
The deal will be legally set in stone only when the final agreement is signed and the money is invested in the company. This typically follows some back and forth between attorneys representing each party and may take up to 60 days to do correctly.
It is crucial to remain patient during this period and be prepared to revisit the deal, perhaps even multiple times. This should mean you have a watertight agreement that kickstarts a fruitful investment relationship for everyone involved by the end of the process.
Move forward
Once you have structured your deal and received the final agreement, you are free to start utilising your investment for your business to pursue your goals.
Remember that you must continue to meet the conditions of the agreement, including only using the money given to fulfil the set-out targets and objectives and alerting investors to any changes within your company that may affect them.
This will enable you to continually meet the terms of the deal and maintain your investor relationship.
Conclusion
When working with an angel investor, it is in both your and their interests to structure a robust deal that aligns with each side. By doing so, you can create the foundations for a long-lasting relationship and avoid any complications down the line.
By understanding what to consider during the process, you can prepare yourself and approach the deal with the knowledge of the options that may suit you. From here, you can decide what you want from the agreement and focus on negotiating an offer that facilities your priorities while continuing to encourage the investor to support you.
If you need help identifying an angel investor to support your business or creating an agreement that works for all parties, we can help.