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Defining key terms in angel investing

In our interviews and podcasts, at our events, and throughout our resources there are a number of terms relating to angel investment that you’ll hear come up often. Here’s a quick glossary that you can refer back to at any time.

What is an Accredited Investor?

An accredited or sophisticated investor is an investor with a special status under financial regulation laws. The definition of an accredited investor (if any), and the consequences of being classified as such, vary between countries. (Source: Wikipedia)

Understanding investor accreditation in your country will be incredibly important for you as an angel investor. Generally, securities distributed to the public must be offered under a prospectus; often long and tedious process for both investors and companies. However there are some exemptions from this rule, such as the accredited investor exemption which states that investors meeting certain standards can invest without the company being required to prepare a prospectus.

In the US, according to the SEC, accredited investors must be one of the following:

  • Individuals with income over $200K (individually) or $300K (with spouse) over the last 2 years and an expectation of the same this year
  • Individuals with net assets over $1 million, excluding the primary residence (unless more is owed on the mortgage than the residence is worth)
  • An institution with over $5 million in assets, such as a venture fund or a trust
  • An entity made up entirely of accredited investors
  • If you do not fall under an exemption in your country (ie; if you aren’t an accredited investor) it’s not that you are legally bound from investing – there are just more stringent rules, such as a company needing to offer a prospectus. Know that these rules were put in place to protect you from being taken advantage and from undertaking unnecessary risk. If you are not yet at the status of being an accredited investor, getting to that status should be your first goal. Accreditation rules in Ontario are very similar to the US. In Ontario however, non-accredited investors who are close friends/family to directors, senior officers or control persons of the companies do not need to be accredited in order to invest.

What is an Angel Investor?

An angel investor or angel (also known as a business angel or informal investor or angel funder) is an affluent individual who provides capital for a business start-up, usually in exchange for convertible debt or ownership equity. (Source: Wikipedia)

This is you! Angel investors provide funds to startups in exchange for equity and or debt. Understanding this relationship is the first building block as your journey as an angel investor.


A Capitalization table (or cap table) is a table providing an analysis of the founders’ and investors’ percentage of ownership, equity dilution, and value of equity in each round of investment. (Source: Wikipedia)

Why you need to know

As an investor you will generally receive debt or equity in exchange for your funds. Your equity in the companies you have invested in will be represented in the capitalization table of those companies, showing your ownership in terms of number of shares and percentage of outstanding shares.

Companies don’t have a standard number of shares, however one million shares would be a pretty standard number. New shares can be issued from time to time and the number of shares within a company is fairly irrelevant. What matters is what percentage of the total number of shares in the company your shares represent. A cap table will show you what percentage of the company your shares represent and will also list off all other shareholders in the company, their ownership and for each past investor, the cap table can show how much of each class was bought and how many shares of that class are owned as a result.

You can learn a lot about a company by looking at its cap table. As an investor you will want to see a company’s cap table prior to investing. Among many others, some warning signs you could identify by reading a cap table would be higher valuations in past round (aka a down round), low percentage of ownership for founders (which could result in low motivation) and inactive founders (people no longer active in the company holding large equity stakes, acting as dead weight on the cap table).

In investing, the cash-on-cash return is the ratio of annual before-tax cash flow to the total amount of cash invested, expressed as a percentage. It is often used to evaluate the cash flow from income-producing assets. Generally considered a quick napkin test to determine if the asset qualifies for further review and analysis. Cash on Cash analyses are generally used by investors looking for properties where cash flow is king, however, some use it to determine if a property is underpriced, indicating instant equity in a property. (Source: Wikipedia)

Why you need to know

You may hear other angels or venture capitalists refer to cash on cash returns. When you hear this, all they are referring to is the multiple they made on their initial investment. For example, I invested $20K and got back $60K, I had a 3x cash on cash return.

A convertible bond or convertible note (or a convertible debenture if it has a maturity of greater than 10 years) is a type of bond that the holder can convert into a specified number of shares of common stock in the issuing company or cash of equal value. It is a hybrid security with debt- and equity-like features. (Source: Wikipedia)

Why you need to know

Convertible debt is a very popular way for companies to raise angel financing. Its very important that you understand the difference between convertible notes and priced equity rounds. You will also need to understand the key terms of a convertible note.

First off, investing through a convertible note does not immediately give you shares in a company, which a priced round would. A convertible note is technically a loan that will convert to equity in a company when one of a number of triggers happen. Triggers usually include a company raising more financing above a certain dollar value or the note maturing (based on a certain date specified in the note).

Convertible notes are fairly standard in terms of structure but have different valuation caps, discounts, interest rates, and maturity dates depending on the deal. A cap in the context of a convertible note is the highest valuation at which your investment would convert to equity, the discount is the amount off the valuation at the time of conversion that you will receive as an early investor. The cap is meant to protect you from converting at a very high valuation if the company raises at a very high valuation in their next round of financing.

Convertible notes are very popular because they avoid the need to price a company at the time of an early stage deal, which can be very difficult, and they are also much faster and cheaper to execute than priced rounds which require much more documentation.

Crowdfunding is the practice of funding a project or venture by raising monetary contributions from a large number of people, typically via the internet. (Source: Wikipedia)

Why you need to know

As an investor it’s important to understand funding options that companies have so that you can assist your companies in finding alternative sources of capital and so that you understand an entrepreneur’s BATNA to raising money from you. You may recommend that companies you’re invested in use these platforms to raise future rounds, or you may personally use these platforms to find and source deals.

Crowdfunding via platforms like Kickstarter and Indiegogo is a great example of non-dilutive capital, money that can be raised without giving up any equity. There are also new crowdfunding platforms emerging that crowdfund equity financing rounds for startups, platforms like FundersClub and AngelList, however many regions still place significant restrictions on equity crowdfunding.

For Canadians, it is useful to know that recently the securities regulators of British Columbia, Saskatchewan, Manitoba, Québec, New Brunswick and Nova Scotia have implemented, or expect to implement, registration and prospectus exemptions that will allow start-ups and early‑stage companies to raise capital through crowdfunding in these jurisdictions, subject to certain conditions.

Stock dilution is an economic phenomenon resulting from the issue of additional common shares by a company. This increase in the number of shares outstanding can result from a primary market offering (including an initial public offering), employees exercising stock options, or by conversion of convertible bonds, preferred shares or warrants into stock. (Source: Wikipedia)

Why you need to know

Let’s say you make an investment of $10K for 1% of a company in its first round of financing – it’s important to understand you will not forever own 1% of the company. Every time the company issues additional shares or securities convertible into shares, your % ownership will decrease proportional to the raise. For example, in the case of the $10K investment referred to above, if the same company then gives away 10% of the company for $5M in their next round of financing, your % ownership on a fully diluted basis would decrease to .9%.

Note that while the definition provided above only refers to common stock, dilution can be extended to all classes of shares.

A dividend is a payment made by a corporation to its shareholders, usually as a distribution of profits. When a corporation earns a profit or surplus, it can re-invest it in the business (called retained earnings), and pay a fraction of this reinvestment as a dividend to shareholders. (Source: Wikipedia)

Why you need to know

While most startup investing results in returns in the form of acquisitions or IPOs, sometimes companies grow to be profitable and choose to remain private, for at least some amount of time. When the company has profits at the end of the year, the company’s board of directors can choose to hold those profits, reinvest them in the business, or to distribute them among shareholders. In some of your investments you may receive a portion of your return in the form of dividends. Dividends don’t just get issued to shareholders of private companies, they can also be issued by public companies – but dividends relating to private companies are likely more relevant to you as an angel investor.

Note that dividends can be paid out to shareholders of a certain class (for example Class A Prefs) to the exclusion of other classes of shares in the Company – it’s a good thing to review the articles of a company to learn more about dividends on a particular class of shares.

Initial public offering (IPO) or stock market launch is a type of public offering in which shares of stock in a company usually are sold to institutional investors that in turn sell to the general public, on a securities exchange, for the first time. (Source: Wikipedia)

Why you need to know

IPOs are generally seen as the most sought after liquidation event for startups. That is not to say that you can’t make very large returns off of companies being acquired, but many investors and entrepreneurs dream of creating self sustaining long term businesses, and the way liquidity is achieved for this type of company is usually through an IPO – where shares are priced and opened up to the general public and investors can begin selling their shares into the public market to realize their return. In this case, the securities would be traded publicly on a stock exchange such as the NYSE in the US or the TSX in Canada. After an IPO the company would be subject to more stringent rules such as continuous disclosure obligations

The internal rate of return (IRR) or economic rate of return (ERR) is a rate of return used in capital budgeting to measure and compare the profitability of investments. It is also called the discounted cash flow rate of return (DCFROR) (Source: Wikipedia)

Why you need to know

Where most venture capital firms measure their returns based on multiples with little regard for the time required to makes that return (ie; we made 4x on a $100K investment), it can sometimes be in an angel investor’s interest to weigh the pros and cons of multiples vs. how long their cash is tied up in a company. The best way to track this is through IRR. The IRR makes it easy to measure the profitability of your investment and to compare one investment’s profitability to another.

Liquidation is the process by which a company (or part of a company) is brought to an end, and the assets and property of the company are redistributed. (Source: Wikipedia)

Why you need to know

In order to get returns as an angel investor you will be relying on your investments reaching a liquidity event. The main exception to this would be if you are invested in a highly profitable venture that remains privately held and simply provides returns by issuing dividends to shareholders. The most common liquidation event for companies is acquisitions, where a larger company acquires a startup for a specific price – under a variety of conditions, and proceeds are distributed to investors. A less frequent, but more highly sought after liquidation event would be an IPO, where a startups shares are priced and offered on the public market. As an investor, you want to help your investments optimize for the best possible liquidation event, that will provide the highest multiple on your initial investment.

Two or more partners united to conduct a business jointly, and in which one or more of the partners is liable only to the extent of the amount of money that partner has invested. Limited partners do not receive dividends, but enjoy direct access to the flow of income and expenses. (Source: Investopedia)

Why you need to know

If you have ever wondered where venture capital firms get their money to invest from, it is from Limited Partnerships (LPs) who invest directly into the fund. Setting up LPs rather than investing directly personally can protects the investors in certain circumstances from liability and can be used for income tax planning purposes. Limited partners who engages in managing the limited partnership can lose that partner’s limited liability. Setting up a corporation is another way to protect an investor from personal liability.

An option is a contract which gives the buyer (the owner) the right, but not the obligation, to buy or sell an underlying asset or instrument at a specified strike price on or before a specified date. The seller has the corresponding obligation to fulfill the transaction – that is to sell or buy – if the buyer (owner) “exercises” the option. (Source: Wikipedia)

Why you need to know

Issuing options is generally used as a way of getting or retaining key talent for a company. It can also be used as a way of incentivizing advisors or as giving additional equity back to a founder who the board believes has been diluted too heavily in previous rounds of investment. Where options may come up in your negotiations as an investor is when you are determining the size of an option pool. When option pools are added after you invest, your shares get diluted on an ownership basis. For example, if a new 10% option pool is created, your ownership will go down by 10%. It is because of this dilution that investors generally ask that option pools are created prior to their investment, so that only the founders experience the dilution. This is only usually relevant in negotiations priced rounds. In these negotiations, investors usually want a large option pool created, so that they aren’t diluted by future options being created, and founders want smaller option pools so that they limit their dilution now and so that investors have to share in the dilution if new options need to get created in the future.

Participating preferred stock is preferred stock which provides a specific dividend that is paid before any dividends are paid to common stockholders, and which takes precedence over common stock in the event of a liquidation. This form of financing is used by private equity investors and venture capital firms. Holders of participating preferred stock get both their money back (with interest) and the money that is distributable with respect to the percentage of common shares into which their preferred stock can convert. (Source: Wikipedia)

Why you need to know

As an entrepreneur, seeing participating preferred shares in a deal is a bit scary. That said, participating preferred shares are very much in an investor’s interest. This type of preferred shares (defined in full under Preferred Shares in the glossary) essentially allows an investor to double dip. At a liquidation event the investor gets their money back off the top, and then their pro rata share of the remainder. This isn’t so bad when a company has a very strong exit, because the relative benefit the investor gets for getting their return of the top of the deal is small, but it is really bad for entrepreneurs when they have small exits. Take for example a company that has raised $10M, and whose investors own 30% of the company. If the company were to sell for $20M, the investors would first get back their $10M and then take 30% of the remaining $10M. Resulting in investors getting $13M and other shareholders splitting $7M. More founder friendly investors tend to not ask for participating preferred shares, more risk averse investors, or investors that have leverage in negotiations may ask for this type of shares.

Preferred shares (also called preferred stock, preference shares or simply preferreds) is a type of stock which may have any combination of features not possessed by common stock including properties of both an equity and a debt instrument, and is generally considered a hybrid instrument. Preferreds are senior (i.e., higher ranking) to common stock, but subordinate to bonds in terms of claim (or rights to their share of the assets of the company)[1] and may have priority over common stock (ordinary shares) in the payment of dividends and upon liquidation. Terms of the preferred stock are described in the articles of association. (Source: Wikipedia)

Why you need to know

In short, you would rather have preferred stock in a company than common stock. Common stock is the type of stock initially issued to founders, preferred stock is a higher class of stock, generally issued in funding rounds that grants investors special rights. For example the right to get paid back first in the case of a liquidation event for the company. The terms of the pref stock are described in the “articles of incorporation.”

An arrangement among a company’s shareholders describing how the company should be operated and the shareholders’ rights and obligations. It also includes information on the regulation of the shareholders’ relationship, the management of the company, ownership of shares and privileges and protection of shareholders. (Source: Investopedia)

Why you need to know

While a term sheet will highlight the key points of an agreement, it is ultimately the shareholders agreement that will formalize the majority of your rights as an investor. Shareholders agreements include much more detail, and will usually be drafted by and reviewed by yours and the company’s legal counsel after a high level agreement is reached between you and the company in the term sheet stage. That said, it’s important that you review and understand the shareholders agreement as well as you do the term sheet, as this is the ultimate agreement that will hold up in court and in all further conversations once the financing is completed. In certain circumstances a shareholders agreement can set out board nominees who can be nominated by a majority of a certain class or by a particularly large institutional investor

Some companies they may not have a “shareholders agreement” but rather similar provisions included in a voting agreement, investor rights agreement, right of first refusal and co-sale agreement.

Super angel (or “super-angel”) investors are a group of serial investors in early stage ventures in Silicon Valley, California and other technology centers who are particularly sophisticated, insightful, or well-connected in the startup business community. (Source: Wikipedia)

Why you need to know

Super angels are an interesting breed, in many ways they are similar to early stage venture capital firms, simply due to the size of check they are able to write, the number of deals they do, or the type of doors they are able to open for company. For examples of ‘super angels’ you can check out Forbes list of “The Most Influential Angel Investors On AngelList”. As you are learning about angel investing, it would be good to follow some high profile super angels to learn from their investment strategies and networks.

A term sheet is a bullet-point document outlining the material terms and conditions of a business agreement. After a term sheet has been “executed”, it guides legal counsel in the preparation of a proposed “final agreement”. It then guides, but is not necessarily binding, as the signatories negotiate, usually with legal counsel, the final terms of their agreement. (Source: Wikipedia)

Why you need to know

While you won’t necessarily see term sheets for every investment you make you will likely come across many term sheets when looking at companies raising a round of financing from multiple investors — either in a priced round of financing or through convertible notes. Term sheets are a simplified way of understanding all of the key points of a deal, like valuation and your rights as an investor. Generally most high level negotiation will happen at the term sheet level, before lawyers go in and draft the final agreements. While term sheets are non binding, it is not good practice to agree to or sign a term sheet when you do not agree on all points. Term sheets often include a “confidentiality” clause which the parties are bound by – this ensures that the due diligence process can be conducted without risk of breaching the company’s confidentiality. As you see more and more term sheets you will get better at pulling out key information and will start to notice when anything unusual or non-standard.

An investor who either provides capital to startup ventures or supports small companies that wish to expand but do not have access to public funding. Venture capitalists are willing to invest in such companies because they can earn a massive return on their investments if these companies are a success. Venture capitalists also experience major losses when their picks fail, but these investors are typically wealthy enough that they can afford to take the risks associated with funding young, unproven companies that appear to have a great idea and a great management team. (Source: Investopedia)

Why you need to know

As an angel investor you will usually invest in companies before they raise money from VCs as VCs generally participate in later stage rounds of funding. When investing you will need to ensure that you are structuring deals in a way that still leaves room in the cap table for further VC rounds and that doesn’t over or under value a company — all of which could lead to making the company you are investing in unattractive to future VCs. You will also want to try to reserve the right to preserve your equity stake in your investments, in future rounds so that you don’t get squeezed out of the cap table when larger rounds are raised from VCs. Note that in some VCs may not agree to other/current shareholders participating in a future round, despite any past agreements that have been made to earlier investors.

Vesting is to give an immediately secured right of present or future deployment. One has a vested right to an asset that cannot be taken away by any third party, even though one may not yet possess the asset. When the right, interest, or title to the present or future possession of a legal estate can be transferred to any other party, it is termed a vested interest. (Source: Wikipedia)

Why you need to know

Vesting will be most relevant to you as it applies to founder shares in their company. A common reason startups fail is founder disputes, someone leaves, they don’t agree on the future of the company etc. Vesting is a great way to protect a company from one founder leaving and walking away with their portion of the company a few months after you invest. What vesting does is it grants founders shares over time. A standard vesting clause would be 4 years, with a 1 year cliff. Meaning 25% of the shares vest after the one year anniversary and then shares vest monthly from that point on. For example, let’s say you own 10% of a company and each of its two founders own 45%. With a 4 year vest, 1 year cliff – if either of the founders left the company within the first year of the vesting agreement they would receive zero shares. If one founder leaves 1.5 years in they would receive 35.4% of their shares (15.93 % of the company), rather than 100% of their shares or 45% of the company if there were no vesting agreement. If they stay all 4 years they receive all of their shares. Without vesting, no matter when a founder left, they would get to keep 100% of their shares. Most vesting agreements accelerate vesting in the event of a sale, meaning that if the company sold 6 months after the vesting agreement was put in place, founders would automatically vest 100% of their shares. As an investor, it’s in your interest to protect your investment by asking founders to be put on vesting agreements. For companies with more than one founder, it is also very much in the interest of both founders to protect themselves with this type of agreement.


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