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After investing in startups for twenty years and talking with thousands of angel, venture capital, and other startup investors, I’ve seen the biggest challenge is finding the exit. If you have invested as a startup investor, you know how easy it is to get into these deals and how hard it is to get out. If you are new to startup investing, you will soon learn how much it takes to grow a business. It’s not for the faint of heart.
In funding startups, remember, not every startup should receive funding.
If the company is not ready for funding, they will not only waste the money but also hurt their reputation in the community.
Angel Investors look for a 44% IRR. IRR is the Internal Rate of Return and represents the return on investment concerning time, unlike ROI, which is return on investment without regard to time. The time value of money is important and should be part of your investment metrics.
Also, there are many sources of funding for startups, of which angel investing is only one.
There are venture capitalists, family offices, and more. Angel investors occupy a unique place in the startup funding ecosystem. It’s typically the first money in after family and friends funding is over.
Angel funding is limited compared to venture capital or family office funding, which has deeper pockets. The longer you stay in the deal, the greater your risk for dilution by these follow on funders. Also, make sure you understand the value of your investment. While the absolute dollar amounts may not be as large as a venture capital fund, angel funding helps the startup cross the funding gap.
To achieve an exit, you must define it yourself as the vast majority of startups will not do so.
The key to a successful exit is a deal structure that gives you some control after signing the check. Equity only term sheets give investors little say in the future of the company or how to exit. You must have it in writing before you sign the check. Trying to come to an agreement after the signing is almost impossible as the gap between the startup and the investor is too significant to close.
The deal structure is a Convertible Note with a redemption right for 3X your investment to be returned at year 3 of the investment at ‘Investor Sole Discretion.’ I call it the ‘3x in 3’ term sheet. On the third anniversary of signing the note, the investor has the option to convert the original investment to a three-times return ($100K in is $300K out) or to go on the cap table as an equity investor.
In reality, there are many choices. In most cases, the startup is motivated to keep your funds in the deal and will negotiate terms to achieve it.
As an investor, you must keep in mind what is suitable for the startup and yourself. In most cases, you will have ample opportunity to structure the 3X into a range of choices, including debt, equity, and cash.
If you want to provide advisory services, then set it out up front with a clear definition of the work to be done and the compensation paid. At the very least, include a clause that gives you an advisory fee for work done with a stated hourly rate if the opportunity arises in the future.
Hall T. Martin is the founder and CEO of the TEN Capital Network.TEN Capital has been connecting startups with investors for over ten years. You can connect with Hall about fundraising, business growth, and emerging technologies via LinkedIn or email: firstname.lastname@example.org