Cutting a fair deal with seed stage investors
There is much talk among entrepreneurs as to what constitutes a “fair” angel deal. Specifically, how much of the company do I have to give up to get a deal done? Having both invested as an angel and been a recipient of angel financing, I never thought about it in those terms. Wearing my angel investor hat, my playbook for how I approached a potential investment was as follows:
- Do I understand the market? If so, go to 2. If not, end.
- Do I love the founders? If so, go to 3. If not, end.
- Do I have a good sense for what constitutes “success” and the scale of potential market opportunity? If so, go to 4. If not, end.
- What is the right amount of money to raise given the state of the product, the cost of hitting key milestones and added cushion for missing key release dates/taking longer to achieve product/market fit and customer traction?
- Do I want to lead the syndicate? If so, develop terms that will drive the syndicate. If not, see who the syndicate lead is and make sure I’m comfortable with them representing the class in the negotiations as to valuation, terms and board representation.
- Are there comps in the marketplace from which to set pre-money valuation?
- What magnitude of option pool is required given the number of founders and number of key positions to be filled in the near term?
Once I get to 7, valuation is a function of comps, market conditions, competitive environment, experience of the team and fairness. I have never and would never do a deal where the investors own half the company out-of-the-gate. That is just terrible deal hygiene and is certain to create misalignment of motives in short order. But is the appropriate ownership position for angels 15%, 20% or 30%? It is simply not possible to answer without more context. In general, however, I’d say that 25-35% probably represents the fat part of the distribution as far as my own experience is concerned.
Entrepreneurs should be focused on the following (in this order): people, people, people and valuation (the investor correlate is people, people, people and then product and market). Great mentors and advisers - the best kind of early investors - can help to de-risk a seed stage company. Getting people who are “just money” may yield a higher pre-money valuation, but may well cost entrepreneurs far more when times get tough and good strategic advice would be helpful from people with aligned motives yet are not part of the mix. Think long and hard about syndicate construction and by all means insist on a fair deal, but don’t make valuation THE key decision criterion. Success is the outgrowth of hard work, vision and the ability to be flexible and to deal with adversity, and a strong seed-stage investor group can pay vast dividends by helping navigate these early challenges.
