Angel Investor Terms: Everything You Need To Know
Angel investor terms are used to define the relationship between an investor and the company receiving the investment.3 min read
2. What Is Seed Capital?
3. How Is a Startup Valued?
4. How Do Stock Holdings Work?
Angel investor terms are used to define the relationship between an investor and the company receiving the investment. The terms of this type of agreement are established with a non-binding document called a term sheet. This is similar to a letter of intent as it creates the intention of moving forward with a partnership and often leads to a legally binding agreement.
What Is Included on a Term Sheet?
The term sheet for an angel investor is usually about 10 pages long, compared to 20 pages or more for a venture capital term sheet. These pages summarize the deal's proposed terms and can be used to attract potential investors and as a guide for attorneys to create the legally binding investment agreement.
Term sheets often contain complex legal language, so less experienced individuals should consult an attorney. The provisions of a term sheet contain anti-dilution protection, drag-along rights, liquidation preferences, board composition, investment round size, and share pricing. Elements to consider include:
- The deal must be beneficial enough for the investor that he or she is willing to take on the associated risk. The investor wants to avoid dilution and ensure first return on their investment.
- Investors want to avoid terms that allow future deals to diminish the value of their investment or make them lose liquidity priority.
- Some investors may want to have some control over the company, including influence on critical decisions.
- Investors will want to ensure that they receive their investment back in all positive and negative investment scenarios.
The term sheet should be structured in such a way to make the deal a win-win for both parties.
What Is Seed Capital?
Often provided by the company's founder and his or her friends and family, seed capital is the initial funding source for a new business. This occurs before any major investment rounds and is known as the seed stage. Often, the company in question is not yet profiting or is earning only a small amount of revenue. The seed stage helps to build the business and generate the interest of venture capitalists.
How Is a Startup Valued?
The value of a new business is established based on the price someone else would be willing to pay for the company on the open market. Types of valuation include:
- Pre-money valuation, which is the worth before an angel investor puts money into the business
- Post-money valuation, which is the worth after you receive a cash infusion from an angel investor
A startup undergoes valuation before every round of funding. Often, entrepreneurs accept a lower price per share in exchange for added flexibility.
How Do Stock Holdings Work?
Your company can issue many stock classes, each with its own rights. For example, preferred stock can be issued to investors and allows them to receive dividends with priority over common stockholders. Common stock is often issued to employees and founders.
A detailed list of stock ownership by individual and entity is called a capitalization table. It lists the ownership percentages of each owner, which must add up to 100 percent. Think of the capitalization table as a spreadsheet of sorts.
Owners earn their stock holdings over time through a process called vesting. This provides the original founders and owners a reason to stay with the company. For founders and employees, the vesting period is often three or four years. If the person leaves before the vesting period is over, a portion of the stock will be returned to the company.
When you give another individual or business part of your company's stock, this is called dilution. You now own less of the company to make room for another owner.
When your company receives a loan that can be repaid with stock, this is called a convertible note. This type of loan has a maturity date and an interest rate; it can often be converted at a discounted rate in the future.
Often, an investor will require a certain percentage of stock shares to be dedicated to future employees through a stock option pool. This also dilutes your ownership stake and can range from 5 to 20 points of equity depending on the agreement.
If you need help with angel investor terms, you can post your legal need on UpCounsel's marketplace. UpCounsel accepts only the top 5 percent of lawyers to its site. Lawyers on UpCounsel come from law schools such as Harvard Law and Yale Law and average 14 years of legal experience, including work with or on behalf of companies like Google, Menlo Ventures, and Airbnb.