When Do Seasoned Angel Investors Invest in Common Stocks?

If given the choice, founders would issue common shares to investors, as it would speed up negotiation, keep the capital structure straightforward by having only one class of stock, and put investors on the same level as common shareholders.

* This is Part 3 of a 3-part series. Visit Part 1 at “Angel Deals: Quick Discussion on Common and Preferred Stocks.”

Issuing only one class of stock also allows the company to incorporate as an S corporation for tax advantages. However, as elaborated in “C Corps vs. S Corps vs. LLCs: Which Corporate Structure Should Angels Invest in and Why the Form of Entity Matters,” you may want to reconsider investing in S Corps if you were to become a professional angel. Companies, too, should think about whether to incorporate as an S corporation if they plan to raise money from sophisticated investors.

Unless the company is perceived as “hot,” most early stage companies don’t have the leverage to issue common stocks to experienced investors.

Experienced Angels Invest in Common Stocks When…

Photo by: John-Morgan

Experienced investors almost always push for preferred stocks, but this is not to say that they would never purchase common shares. There are always circumstances under which investors may consider purchasing common stocks, such as:

• The entrepreneur is experienced and has put much of her own money into the company, and the investor trusts (based on personal experience with that individual) that the entrepreneur will treat investors well, remarks Dan Rose, chairman of Seattle Alliance of Angels. [3]
• The founder is a well-known, successful, serial entrepreneur – someone in whom investors fight to invest.
• The deal is perceived as “hot” or competitive, where the founder has received multiple term sheets from different investors. This often occurs when investors believe the company has significant upside potential, i.e., the next Google.

On a related note, an experienced founder who has the luxury to choose her backers and doesn’t want to give too much control to investors may prefer a term sheet that prices her company at a lower valuation in exchange for common shares, as opposed to one that offers a higher valuation but demand for preferred shares.

Similarly, she would likely rather opt for a term sheet that prices her company at a lower valuation in exchange for preferred shares with fewer rights, as opposed to one that offers a higher valuation but demands more rights.

* This is Part 3 of a 3-part series. Visit Part 1 at “Angel Deals: Quick Discussion on Common and Preferred Stocks.”

References