A Practical Guide to Angel Investing: How to Achieve Good Returns

Chapter 4 - Make Good Deals

Make Good Deals

There is no single correct deal structure, set of terms or valuation.

Unlike the public stock market, there is no exchange that sets "fair" market prices and standard shareholder terms. Investors and entrepreneurs will naturally disagree over their preferred deal and over how big, risky, fast or successful the company will become.

Larger investments with multiple co-investors and syndicate partners start to look more like venture capital (VC) agreements with complicated provisions. For smaller investments, it makes no sense to incur high legal fees on complex structures, so common share structures are often the best choice for smaller deals.

Angel investors vary widely over their preferred deal terms. In many cases, these preferences are driven by their local ecosystem's preferred terms, government incentive programs, or their local Angel group. The anticipated future financing needs of the company may also influence the deal structure (e.g., a future VC round is expected, or it could be follow-on lending).

Momentum Angels, who are jumping into a hot deal, typically have no ability to influence the deal terms. They are either in or out of a larger deal that is controlled by others.

There are three primary aspects of any deal:

• Deal structure (section 4.2 – common shares, preference shares, debt, convertible debt, discount to next round, or Simple Agreement for Future Equity [SAFE agreement])

• Valuation (section 4.3 – how much of the company does your money buy?)

• Term sheet conditions (section 4.4 – board seats, anti-dilution, liquidation preference, pay-to-play, tag-along, drag-along, information rights, etc.)

Different provinces and different Angel groups will have different preferred deal structures. In some cases, these are strongly influenced by government incentive programs or co-investment requirements. For example, in New Brunswick and Nova Scotia, the government will provide an investment tax credit as long as the investment is for common shares. As a result, many Angel financings in those provinces use common share structures.

Provincial Angel Investor Tax Credits

Top 5 Canadian Angel Groups by Number of Investments Made in 2014