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my partner and I are creating a start-up and I was wondering if anyone could give me some advice about negotiating with an angel investor. The start-up is a social networking website for pets. We have a full business plan and design of this concept, which we pitched to an angel investor today, and they are really interested. They are willing to give us $50,000+ with office space, resources, etc. for 50% of the company and if we reach a certain amount of users (3,100) by the 4th month they will dilute their shares to a locked 26.1% returning the 23.9% to us. (What is this called when they return a % of shares to us after a milestone?)

They also said they would bring us an additional $500,000 for 10% of the company after the 3rd month once we prove ourselves, but this is all an assumption, so we are not counting on this.

*Do you think this makes sense and is a good plan, or no? *We don't really want to give them the 50% to start; we would prefer (obviously) to just give them the 26.1%. Why do you think they want to do this? *We are planning to negotiate for $75,000 for 26.1% non-dilutable.

PLEASE let me know your thoughts.

Thank you!

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4 Answers

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No Game.

Check out how YCombinator, TechStars, AngelList etc. work. They take < 10% of your company for tens of thousands of dollars.

Quote from YCombinator FAQ:

How much do you invest?

Usually $11,000 + $3000 per founder. So $17,000 for two founders, $20,000 for three or more. Occasionally we invest more. The goal is usually to give you enough money to build an impressive prototype or version 1, which you can then use to get further funding.

What does Y Combinator get out of this?

Stock in the startup, from 2-10% of it. Usually 6 or 7%.

Investors like this are either inexperienced or not serious. In either case they're not good.

You may also want to check out this answer on equity release at seed funding.

Tim made a point in the comments, and I'd like to clarify. I'm not saying you should play it big and release < 10%. I'm saying that 50% is just off the charts. Even 26.1% is very, very high. I'm sure you can do better.

edit: YCombinator have published standardized papers for Seed Rounds that are generally accepted as VERY good. I suggest you read them, as well as Brad Feld's term sheet series, to fully understand startup investings. Your valuations may differ, but your investors are suggesting a very non-standard deal that may just screw up your future financing.

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You are not comparing apples to apples. YC, TS, et al are great IF YOU CAN MAKE IT IN but to use them as examples is not being fair. If it were me I'd negotiate for a smaller percentage but give them control rights of certain events like dilution, transfer of ownership, etc. – TimJ♦ Dec 16 '10 at 16:54
Tim, I agree. But this is just off the charts. 10-25% for seed is very common, if you get a good valuation. More than 25% and you're hampering your possible follow on investments. – John Sjölander Dec 16 '10 at 17:44
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Although comparing YC to an Angel isn't exactly the same, I still think it's a fair comparision. For one, although getting into incubators is extremely competitive, you are not guaranteed to get Angel investment either. You have to prove yourself in either case. Also, although the terms you get from an incubator are a lot friendlier than what you would get from an Angel, comparing the two shows exactly how off (and ridiculous) this deal is. – Zuly Gonzalez♦ Dec 19 '10 at 15:12
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Do your due diligence: have they invested in any famous startup? They seem to be some kind of incubator, if they want to provide you with space.

50% is wrong, unless it's a super handson incubator, and even then. The giving back of equity based on milestones doesn't make much sense. Suppose you don't hit your milestone. The startup is not succeeding as expected. So they keep more of something worth nothing. What do you think will happen? You'll quit in disgut. So what's the value to them, of forcing such a deal on you?

Really, look around. My impression is that you have very little (some powerpoint, a plan). Make progress, execute and launch something. You'd be amazed how far you can go without funding nowdays. Then look for real angels.

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Alain is right. If you give up 50% of the company now, future investors are very likely to refrain from investing more money down the line. You become uninvestible because a) you don't have enough stake left in the company to motivate you (founders usually have very little (10-20-ish %) stock at the point of sale) b) the first investors will seem to strong to the new investors, who actually would rather do business with you than with your investors. – John Sjölander Dec 16 '10 at 20:12
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So, should we ask we would like 75k for locked 26.1% instead of 50k for 50% of the company and if we reach a certain amount of users (3,100) by the 4th month they will dilute their shares to a locked 26.1%?

Do you have any suggestion for our negotiation? Thank you!

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Tip: You can continue the discussion in the comments below answers, instead of posting new answers to your own questions. :-) – John Sjölander Dec 16 '10 at 20:06
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Thank you Alain. Our investors have their well known own start up that raised over 4M within past two years. They're providing their hosting, office space etc for 4 months until we get an additional investment which is an assumption however they were able to raise 4M for their start up means they can do this for us. Until we hit this milestone they're going to hold %50 of the company however we're not comfortable with this. We want to offer them %26.1 non dilutable shares and ask more money but I think as founders we should be able to have non dilutable shares as well such as %20 of the company. Please let me know your thoughts. Thank you!

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So, I have a few questions: a) Can you please tell us where the 26.1% comes from? I'm very curious. b) Do you by non-dilutable shares mean shares that will continue being 26.1% of the company after emitting new stock (ie, when you get in new founders, their shares stay at 26.1% even if the don't put any money in the new round) ? – John Sjölander Dec 16 '10 at 20:09
If I'm right on B) you become uninvestible down the line. Future investors are very unlikely to accept that your first investors stock will not be diluted if they put in their hard earned money. It's just not fair. And since they have many more options to invest in companies, than you have with investors investing, they're just going to pass, because you'll seem unattractive (and having bad first investors with unfair advantages). – John Sjölander Dec 16 '10 at 20:15
In my answer above I added a reference to Y Combinators standardized papers for Seed Rounds, as well as a very good series by Brad Feld that explains fundraising and term sheets. You SHOULD read them. – John Sjölander Dec 16 '10 at 20:22
A) They want to maintain controlling interest by taking 26.1% instead of 25%. And yes by non-dilutable shares mean shares that will continue being 26.1% of the company after emitting new stock. They will always own 26.1% of the company. – Jimmy Dec 16 '10 at 21:02
B) When we get future investment our shares will reduce not theirs. So should we give them %25 non-dilutable shares for 75k without milestone agreement and also make 20% of our %75 shares non-dilutable as well? – Jimmy Dec 16 '10 at 21:06

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