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Wednesday, October 04, 2006

Investment discussion

I just come back from a seminar on Angel Investment, and there are a few things I noted that may be of interest to Entrepreneurs:

1- Beware of notes (bridge loans from investors until a round of financing can be completed): notes with discount are not a good idea above 20% of the amount you plan to raise in the coming round (notes typically are to bridge until you can get a real round of financing). The trap is that if you raise too much money that way, you may end up with a problem when the time comes to discuss valuation: if you raised $500K with notes and then you want to raise $1M in a series A round. If the VC/Angels ask for 40% of your company for $1M, then you will also have to give away another 20% to the people with notes (assuming no discount, it will be more if you had a discount included with the note).

2- The other trap with notes, and with friend and family money in general is that you may be tempted to take money from non-accredited investors which will represent a risk for the company, and therefore will pollute your negotiations with future investors. The issue with non-accredited investors is that they could decide to sue if the company does not perform as they expected. And if they are not accredited, they can claim that they were not familiar with investing and they were mislead. Not a good thing.

3- The funding gap (the funding levels that are too high for Angels and too low for VCs) is increasing. It seems that after the clean-up that has happened in the VC industry after the bubble, we have now the same amount of money invested through fewer VCs. As a result, an average VC deal is now closer to $7M (instead of $4M a few years ago). Something that is not going to make the life of entrepreneurs easy...

4- Some good news to finish: some people are trying to help reduce this funding gap by encouraging Angel investment through a tax credit:
"The Access to Capital for Entrepreneurs (ACE) Act of 2006 (HR 5198) was developed to fill a gap in current equity funding between venture capitalists and angel investors. This bill addresses that gap by encouraging accredited investors to increase equity investments in certain qualified small businesses through the creation of a 25% tax credit for accredited investors and certain partnerships (including angel investment pools if all are accredited investors) that invest cash or cash equivalents at an arm's length in a qualified small business (as defined by the Small Business Act)."
More info here