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For a technical explanation of the difference between participating and non-participating preferred stock, see http://www.startupcompanylawyer.com/2007/06/15/wh

by grellas 17y ago

For a technical explanation of the difference between participating and non-participating preferred stock, see http://www.startupcompanylawyer.com/2007/06/15/what-is-the-difference-between-non-participating-preferred-stock-and-participating-preferred-stock/ http://www.startupcompanylawyer.com/2007/06/15/what-is-the-d.... Liquidation preferences at the angel stage are not in themselves too critical so long as they are generally reasonable and 2x/non-participating doesn't work any particular hardship for founders and early-stage employees where the investment amount is in the $1 million range. The problem is the impact on later rounds. If VCs take a 2x liquidation preference, say, for a $10 million investment, then any exit of $20 million or less is a wipeout for founders and early-stage employees. Couple that with the pressure to shoot for a 10x return on whatever that VC investment is and you can get a shoot-for-the-moon mindset that heightens risk on the one side and a let's-cut-our-investment-risk-and-get-rid-of-this-non-performing-startup mindset on the other that heightens risk on the other (assuming the VCs have control, which they normally do). Thus, 2x (or higher) is usually seen as highly unattractive by founders even if its immediate implications at the angel stage are not necessarily bad. In my experience, in all normal investment environments, founders will resist it and fight for 1x only (usually going for participation with a cap). Your experience may vary but this has been mine over many years in Silicon Valley. I can understand the logic of 2x as explained in this fine piece from the angel perspective. On its own terms, it makes sense and is reasonable for that stage. As long as it doesn't spill over into subsequent rounds, it creates no problems in itself.

epi0Bauqu 17y ago
Thx for your comment--that is great validation. I also just found your other great posts (http://www.twitter.com/grellas http://www.twitter.com/grellas). I should have been more clear in my post about my current strategy. I'm really looking for deals that, if successful with the angel money, may not need VC with decent probability, and if they do take VC, it wouldn't be for that much. In other words, I'm less concerned with the risk of follow-on terms at the moment. That being said, I wonder if they can be justified if the angel round is small. Say I it's a $250K round and so the preference takes up $500K. You go to raise $3M VC and the VC says we want 2x because they got it. Can't the entrepreneur say, look that was for the angels because the round was so small and it doesn't make sense for us in a round this large? Of course it is all negotiable but the knee-jerk "we need to get everything they got and more" seems out of place here. Also, I'd personally be fine with participation with a cap. It just seems entrepreneurs are more willing to go with 2x, non-participating. But my experience is very limited so if that's the norm it's fine with me. What terms do you usually see, 1.5x with participation at a 3x cap?
- anamax 17y ago
  > Can't the entrepreneur say, look that was for the angels because the round was so small and it doesn't make sense for us in a round this large? You can say anything that you want. However, remember that they don't care what other people get - they care what they get. FWIW, you should have the comparable position.
- grellas 17y ago
  Thanks in turn for your kind words. Your strategy makes perfect sense for startups that look to take in angel money only or that look to do so at first in hopes of building significant value before approaching VCs down the road, they hope, from a position of strength. This is the going strategy today in the Valley and many of our startups use it. The issue in dealing with the VCs is primarily a psychological one and I would say that, other than in an extremely down investment environment, most would be willing to let go on something like 2x if the market as a whole for VC investments is not supporting it (the long-term norm is 1x - during the dot-bomb phase, it was more like 3x-5x - today it is somewhere in between). So, yes, I think the issue can normally be argued, and argued successfully, especially if the startup is positioned well and can be selective. The terms for participation with a cap will vary widely but, in essence, do not come out much differently in practical terms than would a 2x/non-participating type of preference.

by grellas 17y ago

epi0Bauqu 17y ago

Thx for your comment--that is great validation. I also just found your other great posts (http://www.twitter.com/grellas http://www.twitter.com/grellas). I should have been more clear in my post about my current strategy. I'm really looking for deals that, if successful with the angel money, may not need VC with decent probability, and if they do take VC, it wouldn't be for that much. In other words, I'm less concerned with the risk of follow-on terms at the moment. That being said, I wonder if they can be justified if the angel round is small. Say I it's a $250K round and so the preference takes up $500K. You go to raise $3M VC and the VC says we want 2x because they got it. Can't the entrepreneur say, look that was for the angels because the round was so small and it doesn't make sense for us in a round this large? Of course it is all negotiable but the knee-jerk "we need to get everything they got and more" seems out of place here. Also, I'd personally be fine with participation with a cap. It just seems entrepreneurs are more willing to go with 2x, non-participating. But my experience is very limited so if that's the norm it's fine with me. What terms do you usually see, 1.5x with participation at a 3x cap?

anamax 17y ago
> Can't the entrepreneur say, look that was for the angels because the round was so small and it doesn't make sense for us in a round this large? You can say anything that you want. However, remember that they don't care what other people get - they care what they get. FWIW, you should have the comparable position.
grellas 17y ago
Thanks in turn for your kind words. Your strategy makes perfect sense for startups that look to take in angel money only or that look to do so at first in hopes of building significant value before approaching VCs down the road, they hope, from a position of strength. This is the going strategy today in the Valley and many of our startups use it. The issue in dealing with the VCs is primarily a psychological one and I would say that, other than in an extremely down investment environment, most would be willing to let go on something like 2x if the market as a whole for VC investments is not supporting it (the long-term norm is 1x - during the dot-bomb phase, it was more like 3x-5x - today it is somewhere in between). So, yes, I think the issue can normally be argued, and argued successfully, especially if the startup is positioned well and can be selective. The terms for participation with a cap will vary widely but, in essence, do not come out much differently in practical terms than would a 2x/non-participating type of preference.