A liquidation preference is an investor right that guarantees the return of investor capital before any distributions are made to common shareholders. It typically applies in every liquidation scenario except an IPO. Liquidation preferences are typically set at one times capital invested, but they can go as high as two times, three times, or more in situations where the founder is really desperate.
After the market correction in the tech sector in the early 2000’s we saw companies that were desperate for money taking cash from “vulture” capitalists who structured deals with liquidation preferences of up to 10x, effectively wiping out the interests of previous investors by using these to capture so much of the upside for themselves. It was a difficult period, but as they say, the best time to invest is when there is proverbial “blood on the streets”. And investors with cash saw this during that time period.Read More
Anti-dilution is another one of those somewhat complex concepts that involve plenty of algebra. Basically, the idea is that they are meant to protect investors in the case of a “down-round”, or a capital raise that happens at a valuation lower than the one in which you purchased your securities.
Let’s say you made and investment in a company in 2015 when the market was relatively hot, and the founder convinced you to make a $1 million investment at a $9 million pre-money valuation in the Seed Round. But unfortunately in 2017, the market is not so frothy and the company is almost out of cash. In order to stay alive, they need to raise another $1 million at a $4 million pre-money valuation.Read More
This is one of the more complex but potentially very important aspects of early stage investing. Pro-rata rights help ensure that as an early investor in a company you have the option to maintain your equity stake as the company raises more capital.
Let’s say you acquired 10% of a company that was valued at $10 million post money in 2015. The following year, the company starts to really take off, and decides to raise $10 million at a $40 million dollar pre-money valuation. Without pro-rata rights, the company or its new investors could refuse to let you participate in the round, and your stake in the company would diminish from 10% to only 4%, significantly reducing your potential return if you believed this company had the potential to reach a billion dollar valuation.Read More
Information rights establish just how often the company has to communicate with investors, and what type of information they must provide. Fundraising can be a lot of work for founders, but so can dealing with information requests from investors after the raise. Ideally, most founders would prefer to focus on growing their businesses than providing you with updates. However, investors can often feel they have been left in the dark post-investment if they have not been granted a seat on the board.Read More
A valuation cap is something that applies to convertible notes. A convertible note is a security that is a hybrid of both debt and equity. Notes are issued in the place of priced equity, typically when a company is raising less than a million dollars and does not want to generate the legal expenses associated with a priced round.
When the company issues a larger amount of capital, the notes will have the option to “convert” into the newly issued securities at a pre-set “discount” to the price of the follow-on round. These discounts typically range from 15 to 25 percent. However, in order to provide investors with some of the protections of a priced round, they add a “cap” to the valuation. The “cap” sets the highest valuation that can be used to determine the conversion price of the notes.Read More
Due Diligence may sound like a scary process, but it really just means exercising a reasonable standard of care before making an investment decision. During the due diligence process at 1000 Angels, we get to know the companies we are considering investing in very well. And a lot of that starts with getting to know the founders.
We rely on referrals from other founders, 1000 Angels and experienced investors to help us meet founders that we can trust. If you have meet a founder for the first time and like his or her idea, make sure you do a lot of “asking around” and reference checking before making a decision. Many of the founders we have made investments in we have known for several years before actually writing a check.Read More
There are plenty of great resources on angel investing. Reviewing the 1000 Angels investor video library is a great start. But we also have some books we think you would love to read if you really want to dig deep.Read More