Navigating Angel Investments: Pricing Later Rounds Compared to Seed Rounds

First Congratulations

Congratulations on reaching the milestone of traction and the ramen break-even point after three years. Expressing gratitude for your logical and rational approach, you are asking the right questions for the right reasons. This forward-thinking mindset is critical in the evolving startup ecosystem.

Understanding the Differences Between Seed and Later Stage Investors

It is entirely appropriate to price the new investment differently compared to the previous seed round. The dynamics, timing, and risk profiles of the two investments are distinctly different. It would be unreasonable for a new investment to expect the same deal as the earlier one.

Let's delve into the specifics. For instance, if your first round involved an offering of 150k at an 850k pre-money valuation, resulting in a 1 million post-money valuation for common stock, this was a fair valuation for a tech-focused startup. This valuation is reflective of the assessed risk and potential upside for the investors.

Introducing Convertible Notes for Later Rounds

For your current round, you should consider utilizing Convertible Notes. This is a flexible financing instrument that serves as a loan with the understanding that it will convert into equity when a subsequent professional financing round occurs. The key benefit of this approach is that it provides a compromise between the needs of the founders and investors.

Convertible notes typically come with a discount rate, meaning the investors benefit by receiving a lower conversion price. For example, a 20% discount on the next professional valuation would be common. This discount incentivizes investors to be supportive of future fundraising efforts. If the angel investor is not highly sophisticated, they might invest on these terms without issue. However, it's also reasonable for the angel investor to expect a lower conversion price, which reflects the higher risk of the earlier seed round.

Setting the Cap and Future Valuations

The cap on a convertible note should be approximately equal to the existing valuation. For instance, if your valuation is currently at 1 million, the cap on the convertible note should be set close to this amount. This ensures that the terms remain fair and reasonable for both parties. It is important to note that the cap on the convertible note acts as a ceiling on the valuation for the next round, providing a sense of security for the earlier investors.

To provide a more comprehensive understanding of financing structures and convertible notes, I recommend reading my recent book on the subject. The book delves into the intricacies of each financing stage and provides practical insights for successful fundraising.

Conclusion

By understanding and applying the principles outlined above, you can navigate the complexities of angel investments with confidence. Congratulations again on your progress, and good luck with your future fundraising endeavors.

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