by Brad Feld and Jason Mendelson,Authors of Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist, Third Edition
Excerpted with permission of the publisher, Wiley, from Venture Deals: Be Smarter Than Your Lawyer and Venture Capitalist, Third Edition by Brad Feld and Jason Mendelson. Copyright (c) 2016 by Brad Feld and Jason Mendelson. All rights reserved. This book is available at all booksellers.
In addition to VCs, your investor group may include individual investors, usually referred to as angel investors (or angels for short). These angels are often a key source of early-stage investment and are very active in the first round of investment, or the seed stage. Angels can be professional investors, successful entrepreneurs, friends, or family members.
Many VCs are very comfortable investing alongside angels and often encourage their active involvement early in the life of a company. As a result, the angels are an important part of any financing dance. However, not all angels are created equal, nor do all VCs share the same view of angels.
While angels will invest at various points in time, they usually invest in the early rounds and often don’t participate in future rounds. In cases where everything is going well, this is rarely an issue. However, if the company hits some speed bumps and has a difficult financing, the angels’ participation in future rounds may come into question. Some of the terms we discuss in the book, such as pay-to- play and drag-along rights, are specifically designed to help the VCs force a certain type of behavior on the angels (and other VC investors) in these difficult financing rounds.
While angel investors are usually high-net-worth individuals, they aren’t always. There are specific Securities and Exchange Commission (SEC) rules around accredited investors, and you should make sure that each of your angel investors qualifies as an accredited investor or has an appropriate exemption. This has become more complicated with the passage of the JOBS Act in 2012. The best way to ensure you are following the rules correctly is to ask your lawyer for help.
Some angel investors make a lot of small investments. These very active, or promiscuous, angels are called super angels. These super angels are often experienced entrepreneurs who have had one or more exits and have decided to invest their own money in new start-ups. In most cases, super angels are well known in entrepreneurial circles and are often a huge help to early-stage companies.
As super angels make more investments, they often decide to raise capital from their friends, other entrepreneurs, or institutions. At this point the super angel raises a fund similar to a VC fund and becomes a micro VC. While these micro VCs often want to be thought of as angels instead of VCs, once they’ve raised money from other people, they have the same fiduciary responsibility to their investors that a VC has, and as a result they are really just VCs.
It’s important to remember that there isn’t a generic angel investor archetype (nor is there a generic VC archetype). Lumping them together and referring to them as a single group can be dangerous. Never assume any of these people are like one another. They will all have their own incentives, pressures, experiences, and sophistication levels. Their individual characteristics will often define your working relationship with them well beyond any terms that you negotiate.
The Entrepreneur’s Perspective
Don’t put yourself in a position where you can be held hostage by angels. They are important, but they are rarely in a position to determine the company’s direction. If your angel group is a small, diffuse list of friends and family, consider setting up a special-purpose limited partnership controlled by one of them as a vehicle for them to invest. Chasing down 75 signatures when you want to do a financing or sell the company is not fun.
Also, true friends and family need special care. Make sure they understand up front that (1) they should think of their investment as a lottery ticket, and (2) every holiday or birthday party is not an investor relations meeting.
BRAD FELD has been an early-stage investor and entrepreneur for over twenty-five years. Prior to co-founding Foundry Group—a Boulder, Colorado-based venture capital firm—he co-founded Mobius Venture Capital. Brad also founded Intensity Ventures, a company that helped launch and operate software companies. Prior to this, Brad founded Feld Technologies. He is also a founder of Techstars and has been active with non-profit organizations, including acting as chairperson for the National Center for Women in Technology.
JASON MENDELSON has 20 years of experience in the venture industry. Prior to co-founding Foundry Group, Jason was a Managing Director and Chief Administrative officer at Mobius Venture Capital, where he also served as the firm’s general counsel. Besides his experience as a venture investor, Jason has also been a software engineer, startup lawyer, and a co-founder of SRS | Acquiom. He is an adjunct at the University of Colorado Law School where he co-teaches a course on venture capital and entrepreneurship.