AngelBlog - Latest Comments in Exchangeable Shares - a Better Way for Angel Investors

Re: Exchangeable Shares - a Better Way for Angel Investors

bob — Fri, 18 Jun 2010 05:41:02 -0000

Suppose, Basil, that a business with an exchangeable round in place, for whatever reason, ends up doing a subsequent round where next round investors offer typical double dip pref terms.

On the matter of next-round premoney valuation, the exchangeable holders should be aligned with founders' common, which is good. But on the matter of the double dip distribution, unless I misunderstand this, the exchangeable holders will apparently be aligned with the next-round investors.

Ignoring a relatively long-shot stratospheric exit valuation scenario, in the more likely range of decent but unspectacular exits it seems that the double dip will have the more significant impact on founders' interest than would premoney.

Wonder if you have ever looked at this perspective, either in theory or in a practical situation with your experience with this instrument.

Re: Exchangeable Shares - a Better Way for Angel Investors

basilpeters — Thu, 22 Apr 2010 10:56:31 -0000

Great question, cfravel. The short answer is: no this is not causal.

Most VCs today want to make follow on investments into angel backed companies. Dan Rosen explains this well in part 2 of http://www.angelblog.net/An...

The bigger factor is simply that VCs just aren’t investing in many early stage companies http://www.angelblog.net/An...

The other factor is that more and more entrepreneurs and angels now understand that letting traditional VCs invest is simply not a very good business decision unless the company REALLY needs more than $10 million for more on that: http://www.angelblog.net/Ex...

Re: Exchangeable Shares - a Better Way for Angel Investors

basilpeters — Thu, 22 Apr 2010 10:42:23 -0000

Excellent comments Greg.

You are correct that some lawyers will recommend convertibles because the costs are lower. Dan Rosen explains this well in the "Angel Term Sheet Evolution" video available from the link on the left.

But legal costs should not be the determining factor - it should always be the best structure for the company.

It should also be fair to the investors and in my opinion, most convertible deals aren't http://www.angelblog.net/Co...

Re: Exchangeable Shares - a Better Way for Angel Investors

cfravel — Tue, 13 Apr 2010 17:01:01 -0000

You said: "These days, very few angel backed companies are getting follow on investment from VCs,..."

is this causal? Does the presence of angel investors in the picture inhibit the subsequent VC funding? If so, are there specific reasons for that?

Re: Exchangeable Shares - a Better Way for Angel Investors

Greg Boutin — Thu, 25 Feb 2010 23:17:44 -0000

Now that I think of it, low legal setup costs over any sort of share arrangement might also be one of the great advantages of convertible debts.

See Mike Sparr's comment at http://www.matr.net/article... : "I'd like to point out that a Preferred Stock Equity financing will cost the Company between $15,000-35,000 and requires approximately 9 documents, charter ammendment, often re-incorporation to Delaware, etc. If the Fund then insists the Company pays for it's expenses (most common), hopefully with a cap, we can assume another $10,000-15,000. This means that potentially $40,000 of the deal are tied up in legal fees. In addition, a Preferred Equity financing will almost always require D&O (key person + directors & officers insurance) which would range from $5,000-20,000 per year."

On the other hand, convertible debt has minimal legal fees and leave valuation negotiations to the VC.

Now, it seems that with your one page term sheet, you might address this problem, but aren't a lot of those other documents and potential reincorporation etc required.

Hopefully this doesn't come across as critical, because it's not - I am intrigued by the mechanism you suggest and would just like to understand pros and cons fully for potential future application.

Re: Exchangeable Shares - a Better Way for Angel Investors

Greg Boutin — Thu, 25 Feb 2010 23:05:59 -0000

Basil, your website is a fantastic resource, and I look forward to reading your book, which I just bought and will add to the recommended list of books on my company's website.

A question that came up for me when reading your post is that of tax treatment. As Stanford has documented (in 2001 though, so I don't know whether it's still valid), see http://www.gsb.stanford.edu..., the taxation of convertible debt seems much more favorable, a strong point in favor of that instrument.

My angle is a bit peculiar as I am not an angel in the traditional sense, but a consultant seeking to offer equity payment to my client without subjecting myself to the nonsensical immediate taxation rules (in Canada the rules trigger immediate taxes on stock option attributed at nominal cost - for consultants not employees). Convertible debt seem to make the most sense, as it allows me to turn part of my fees into debt and become a sort of small angel in the company.

I could not do that with exchangeable shares. I haven't thought through the tax pros and cons of both instruments for a classic angel, but it would seem that there are (or at least were) tax advantages that explain the attractiveness of convertible debt, which I saw again in use recently at a start-up I assisted.

What do you think about those tax implications?

Re: Exchangeable Shares - a Better Way for Angel Investors

WaterWolf — Thu, 18 Feb 2010 16:17:44 -0000

Each piece of information I gather adds momentum to my project. Thank you Basil.
With Gratitude,
Michael
PVD
(Piscatorial Ventures & Design)

Re: Exchangeable Shares - a Better Way for Angel Investors

chrisco — Tue, 01 Sep 2009 13:24:34 -0000

Good information, Basil, thank you.

RE the fishing pics: Nice catch!

Cheers,
Chris

Re: Exchangeable Shares - a Better Way for Angel Investors

basilpeters — Tue, 01 Sep 2009 10:33:45 -0000

Great question, Chris. While the mechanism of exchangeable shares is well established, the idea of using it in an early stage financing structure is still new. I have used it almost exclusively for almost a decade now. Other angels, and angel fund managers, that I work with have also been using it for several years.

So far, we have never 'lost' this feature on a next round investment negotiation. But I admit the sample size is very small. These days, very few angel backed companies are getting follow on investment from VCs, so this is coming up less and less often.

P.S. Fishing here has been outstanding. I'll email you a photo.

Re: Exchangeable Shares - a Better Way for Angel Investors

cc — Mon, 20 Jul 2009 20:05:11 -0000

Basil, I'm also curious as to next-round investor reactions. What are the metrics and anecdotes? I.e., how many exchangeable-share deals in your database have received next-round investments and what was the outcome (sanitized numbers) and what are the anecdotes? Thanks.

-Chris

PS: How's the fishin? When ya comin' to Sweden?! :)

Re: Exchangeable Shares - a Better Way for Angel Investors

Lucas — Mon, 06 Jul 2009 18:38:02 -0000

Speaking as an entrepreneur, I don't see that this would harm my own interests, and it might help raise seed money. On the other hand it might make it harder to raise followup rounds.

Any thoughts on how series A investors would react? What's your experience so far?