Private Equity 20 Lectures (10) The angel round in the private equity fund | angel round financing

U.S. Private Equity 20 lectures, Silicon Valley investors' legal must, I am American lawyer Liu Xiaoxiao.

Private equity is categorized from small to large into angel rounds, seed rounds, A rounds, B rounds, and C rounds, but among these different stages of financing, the one thing that makes angel rounds different from all the other rounds is that investors who put hundreds of thousands of dollars into startups don't get the angel round shares. And this is not an exception, but a common practice in US venture capital. So why are American angel investors clamoring to sign such an "unequal treaty"?

Credits

In fact, venture capital in the U.S. did not start out this way, but in 2013 and 2014, two U.S. venture capital organizations launched two financial instruments, one is called SAFE (Simple Agreement for Future Investments), and the other is called Convertible Note (convertible note), which are equity financing and debt financing respectively. These two documents add up to just a few pages, but have revolutionized the ecology of angel round investment in the United States.

I. Convertible Note (Convertible Bond)

First, Convertible Note (convertible note).

The Convertible Note is a set of documents developed in 2014 by 500 Startups, now renamed 500 Global, a venture capital organization that invests in tech companies and has invested in 45 companies worth more than $1 billion, including Canva, Gitlab, and Credit Karma. Credit Karma, among others.

The Chinese name for Convertible Note is Convertible Bond.

• Note in the United States is actually the meaning of debt, if it involves borrowing and so on, usually will use Note (debt) this word, visible Convertible Note (convertible note) is a kind of debt, not shares.

• Convertible. What can it be converted into? It can be converted into shares.

Therefore, Convertible Note (convertible note) should be a note that is convertible to equity, can be converted into shares of debt.

In the actual investment process, the investor will first put hundreds of thousands of dollars into the startup, and then set a time limit on the convertible note, which is called Maturity Date (Maturity Date) in the convertible note, Maturity Date (Maturity Date) period is generally between 12 to 24 months, usually 18 months mainly. If the startup can raise a million-dollar round within this period, the angel investor's debt will be converted into shares; conversely, if the company fails to raise a million-dollar round, the angel investor will still be able to get the money back through debt. By using convertible bonds as an investment tool, angel investors can invest in a way that is "attackable and defensible" and protects the interests of angel investors.

And because it is essentially a debt, the terms of Convertible Note (convertible bond) will often agree on the interest rate, Interest Rate (interest rate) is usually 6% to 10%, 8% is the most common.

II. SAFE (Simple Agreement for Future Investments)

Let's look at SAFE (Simple Agreement for Future Investments).

SAFE (simple agreement for future investment) is a simpler investment agreement introduced by YC in 2013.

YC, full name Y Combinator, an American technology startup incubator, has been used to incubate more than 4,000 companies with a total value of more than $600 billion, including Airbnb, Quora, Reddit and Coinbase.

The Convertible Note (convertible bonds) is almost ten pages long, but SAFE (Simple Agreement for Future Investment) is usually only three or four pages long, because the document is so short that people were afraid to use it in the beginning, and it should be said that at least in Silicon Valley, from 2014 to 2017 or so, the Convertible Note (convertible bonds) prevailed, but in recent years, the Convertible Note (convertible bonds) has become the most popular form of investment in Silicon Valley. But in the last few years, SAFE (Simple Agreement for Future Funding) has almost completely replaced Convertible Note as the most dominant angel round investment vehicle. We'll reveal the reason for this place at the end of the video.

Basic Concepts

SAFE (Simple Agreement for Future Investments) is actually a form of equity financing, but it doesn't take up shares - what's going on? Simply put, it is still considered an equity stake in the company's accounting books, but as to exactly how many shares the investor takes, it is up to the next round of financing to go ahead and determine that stake.

Some people may ask, what if the company cannot raise funds in the next round? In fact, for a technology startup, if it can't raise funds in the next round, then in fact, the money in front of the burned out, the company also closed down, so this is not a problem to think about, and we really need to think about is what should be done if the company raises funds in the next round. yc is also through such a point, to further simplify the process of the angel round of financing, and create a kind of financing SAFE (Simple Agreement for Future Investment). SAFE (Simple Agreement for Future Investment) is a financing tool.

There are two main concepts to understand in SAFE (Simple Agreement for Future Investment), one is called Discount and the other is called Valuation Cap, Discount is easy to understand, for example, how much is the purchase price of each share of the next round of investors, the purchase price of each share of the angel round investors will be discounted on the basis of this discount, usually, the price of each share of the angel round investors will be discounted on the basis of this discount. Discount (Discount) is easy to understand, for example, the next round of investors to buy the price per share is how much, angel round investors will buy the price per share in this discount on the basis of a discount, usually 7 to 9%, the most common is 20%.

The Valuation Cap can be a little tricky to understand. Investors of course hope that the higher the valuation of the startup the better, but the angel round investors have already determined the amount of investment, the proportion of shares has not yet been determined, to determine the proportion of shares of angel round investors is actually the next round of valuation. In order to protect the angel investors from too much dilution, the concept of Valuation Cap was born. If the next round of valuation is too high, then the Valuation Cap will be triggered, and the proportion of angel investors' shares will be determined by the Valuation Cap; if the next round of valuation is not ideal, don't worry, the actual valuation of the next round will be used to determine the proportion of angel investors. This also allows angel round investors to "attack and defend" the way to invest, to protect the interests of angel investors.

But after all, SAFE (simple agreement for future investment) is a kind of equity, angel investors have no possibility to get their investment back, so SAFE (simple agreement for future investment) is still more favorable to entrepreneurs than Convertible Note (convertible debt).

III. Thinking about the difference between angel round financing in China and the U.S.

YC and Startup 500 have launched these two angel round financing tools, so you will find that there is no such thing as "angel round shares" in the United States now.

However, in Chinese venture capital, angel round is a round of shares. Here we can think about why there is such a big difference between China and the US in angel round financing.

• Legal costs: In an angel round, the company itself will only get a few hundred thousand dollars, and even after inflation, that might be about $1 million. If the company has to do a very formal set of financing documents for preferred stock, then the legal fees could all be $30,000 to $50,000, or even $70,000 to $80,000 dollars. Especially in an angel round, when the company's future is still uncertain, it's really not necessary to spend so much money to write a bunch of special formal documents. But this problem exists in both China and the U.S. Why is it that in the U.S. such simple financing tools as SAFE (Simple Agreement for Future Investment) and Convertible Note (Convertible Note) have been created, while in China they don't work?

• Capital market maturity: This is mainly due to the maturity of the capital markets in the two places are different, Silicon Valley's venture capital have almost 50 years, the United States venture capital has developed very mature, the industry has reached a consensus on the main terms of the investment, it is easier to accept such a simple financing tools. In China, after all, venture capital is still a thing of the last 20 years, if the investor can't get the real shares, it's hard for him to let go. Imagine if we let China's capital market develop for another one or two decades, it's also possible to develop an angel round financing tool like the one in the United States.

• Seller's Market: As you will notice, both SAFE (Simple Agreement for Future Investment) and Convertible Note (Convertible Note) are more protective of the founders and less protective of the investors than a formal preferred stock financing document. So why is such a financing model popular in the U.S. capital markets? As you may have sensed, after the emergence of AIGC, although it has been half a year, the topic is still hot. I have been in Silicon Valley for almost 10 years, and I can clearly feel that there have been no really exciting new technologies and projects in Silicon Valley in the past decade or so. But the capital in the hands of investors is still accumulating. That is to say, there is a lot of money to invest, but there are very few good projects, which leads to the buyer's market and the seller's market, the strength of the disparity between the changes.

IV. Why SAFE (Simple Agreement for Future Investment) can replace Convertible Note as the most mainstream angel round investment method?

Finally, let's fill in the hole in the middle of the video, why at the beginning of the birth of SAFE (Simple Agreement for Future Investment) no one asked, but if SAFE (Simple Agreement for Future Investment) has been able to replace the Convertible Note (Convertible Bonds) to become a more mainstream angel round of financing tools? This is actually an evolution of the U.S. venture capital, in the last decade or two, Silicon Valley, the number of angel rounds of financing is gradually increasing, on the contrary, some of the large amount of financing, such as a few or dozens of millions of dollars in financing is gradually decreasing. It can be seen that investors are now more and more keen to spread the money to different small projects early stage startups, rather than focusing on larger projects, try not to put the eggs in the same basket, to reduce their own risk. This also leads to the angel round of financing, the scales are gradually tilted to the seller's market, rather than the buyer's market, startups this side will be increasingly strong.

U.S. private equity fund 20 lectures, Silicon Valley investors must study the law, I am the U.S. attorney Liu Xiaoxiao.