Angel investors will generally be pretty forgiving if you don’t know everything there is to know about structuring an angel investment deal or reviewing a term sheet. So don’t get too worked up if you don’t know the details here (why would you?).
All that being said, there are a handful of common angel investment terms that you should be familiar with because they will have a material impact on how your deal looks. As long as you understand the basic concepts, you’ll be in great shape.
Seed Capital (Stage)
Just like it sounds, seed capital is the initial capital that funds a business. Seed capital typically comes from the founder of the company and his or her friends and family.
A seed stage is the first round of capital that is put into a business. This refers to a round that comes before any large investment rounds have been taken on. It is often during the pre or low revenue stages of a company. The capital is typically used to help generate more traction on a prototype or service until it can attract VC’s.
Valuation
The startup valuation of your company represents how much someone other than you thinks it’s worth. We say “someone other than you” because while you may be the person who sets the valuation, until someone else agrees that the prices is valid, and writes you a check based on that valuation, it’s not validated.
Valuation will be the most common term you hear among angel investors. There are two ways the valuation is represented:
Pre-Money Valuation
This is how much the company is worth before the angel investor puts money into your company. So if you set your valuation to be $2 million, and the angel investor puts in $500,000, your pre-money valuation is $2 million.
Post-Money Valuation
This is how much the company is worth after the angel investor puts money into your company. So if you set your valuation to be $2 million, and the angel investor puts in $500,000, your post-money valuation is $2.5 million. You just tack on their investment to the valuation.
Term Sheet
A term sheet is simply a non-binding outline of the terms and conditions in which an investment is to be made. It’s similar to a Letter of Intent in that it indicates a strong interest to move forward, but it’s not the same as guaranteeing an actual deal gets done.
Convertible Note
A convertible note is a loan made to a company that can be converted into stock by the choice of the issuer or holder at certain events. Each note has an interest rate, a maturity date, and may come with the option to convert at a discount at a future round or time.
Dilution
The effect of giving someone else part of the company’s stock is considered “dilution”. It means that you are diluting your equity stake to make room for someone else. When you’re worried about “giving away the company” that’s called dilution.
Cap Table
It’s short for the “Capitalization Table” and means a detailed list of exactly how much stock each entity or person owns. Think of it like a spreadsheet that simply lists names and percentage ownership stakes all adding up to 100%.
Common & Preferred Stock
There are many “classes” of stock that can be issued in a company. Each class may have its own rights and preferences. Investors typically get Preferred Stock which may give them preferences such as the ability to get their investment back first before the rest of the Common Stock holders get their proceeds. Founders and Employees are usually left with Common Stock which typically means you’re the last person to get paid.
Vesting
Vesting is a process by which you “earn” your stock over time, much like you earn your salary. The purpose of vesting is to grant stock to people over a fixed period of time so they have an incentive to stick around. A typical vesting period for an employee or Founder might be 3 – 4 years, which would mean they would earn 25% of their stock each year over a 4 year period. If they leave early, the unvested portion returns back to the company.
Stock Option Pool
When a company takes on an investment, the investor will usually request (read: insist, strong arm, force, drop kick) that you allocate a certain percentage of the company’s shares to a Stock Option Pool for future employees. This sounds all well and good, but it comes out of your portion of the stock, not the investors. Stock Option Pools will range from as little as 5 points of equity to as much as 20 points.
The Least you need to Know
You’re not going to be expected to know every last investment term there is, but if you have a working knowledge of the terms here, you’ll be in good shape. Later on when you get a term sheet and start getting into the details of things like “pro rata rights” and “preferred stock” you’ll be sitting across from an attorney going into more detail.