Angel Notes
As I have noted on many occasions, one of the most common structures for angel investments is a note that converts into shares of a future round at a discount to the price in that round. While this has the advantage, among other advantages, of putting off the moment when a valuation of the company must be agreed to, one client has recently pointed out the flip side to this benefit is that it caps the investor’s upside during the period from the angel investment to the moment of conversion into the future round at an amount equal to the relevant discount. While few angels ever worry about this issue, the point is well taken, especially if you believe that the future investor will require your angel investor to give up some (all?) of her discount in connection with the new round. One possible way to work around the issue of a capped upside is to issue low priced warrants to the angel investor. For some reason, venture investors have less of a tendency to bother with warrants than they do with discounted conversions. Needless to say, using warrants raises a lot of issues including how to price them both in terms of actual dollars and as a percentage of the equity of the company. They also introduce another piece of documentation and therefore complexity and expense, which may be OK or not OK depending in part on how much angel money you are raising.
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