Starting Up the Start-Up: Approaching the Angel Financing Round

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This blog post picks up where the last post in this start-up series left off, with the assumption that the start-up has been in incorporated, completed its founders' round of financing, created an executive summary and pitch deck and is ready to begin the hunt for "angel" investors (as used in this post, the term angel investors will include all types of potential investors in a company's initial or seed round of funding, including founders' friends and family, "super-angels" and early stage funds). There are several different structures an angel or "seed round" can take -- among them, sale of common stock, sale of convertible notes, and sale of a "light" preferred stock. While ultimately, the investor group may have the final say over the structure of the financing, it makes sense to understand the alternatives in advance and approach investors with a clear plan in mind.

Sale of Common Stock. Historically, a start-up's very first round of financing was raised was raised from a small circle often including (if not limited to) the founders, their immediate friends and family and early advisors who have been providing input and guidance to the founders. For the sake of simplicity, this round was often structured as a sale of Common Stock at an agreed valuation. While this is an easy and inexpensive way to go, it provides investors with none of the rights that later investors in the company's preferred stock will have, and leaves them at risk of significant dilution if, in hindsight, the agreed valuation turns out to be too high in comparison with the next round of financing. From the company's perspective, you have now set a valuation for the common stock which acts as a precedent for the exercise price of stock options to be issued to advisors, consultants and early advisors. In practice, this may mean that these options will need to be priced at an exercise price that is higher than would have been the case if the company had pursued one of the alternative financing structures discussed below.

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DISCLAIMER: Because of the generality of this update, the information provided herein may not be applicable in all situations and should not be acted upon without specific legal advice based on particular situations.

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