In talks and my open office hours I get a lot of questions on how this whole financing thing works in an early stage startup. There is always some confusion around angel investors and VC investors and equity.
- There is some confusion about stock options (often referred to as SOP, stock options plan or pool). Generally speaking (and there are exceptions) you should start small at around 5 percent – if you have more, chances are you give away more. Giving out equity lightly will almost always bite you in the back – don’t do warrants, options, shares, etc. for suppliers, partners lightly! Down the road you will have to increase the authorized SOP. 20 percent is a common number if you’re getting bigger. But be aware that any increase in authorized SOP (that means the pool size) will dilute existing stock classes. And if your angels hold a convertible note (basically a loan with interest that converts into Preferred Class A stocks instead of being paid back in cash), then it actually will only dilute your existing (common) stock. There is a good first start on convertible notes at Startup Company Lawyer, back from April 2007 http://www.startupcompanylawyer.com/2007/04/27/should-a-startup-company-raise-its-seed-round-using-a-convertible-note-or-series-a-preferred-stock/ and there is another warning from Chris Dixon in August 2009 why convertible notes might be a bad idea for seed investments http://cdixon.org/2009/08/12/why-seed-investors-dont-like-convertible-notes/
- As already pointed out earlier in a post about percentage of ownership and control, new investors will likely take an equity share somewhere down the road. Fred Wilson has written several posts on that topic back in September and October 2010, and in February 2009:
- Employee equity (http://www.avc.com/a_vc/2010/09/employee-equity.html)
- Employee equity dilution (http://www.avc.com/a_vc/2010/10/employee-equity-dilution.html)
- Founder dilution – how much is normal (http://www.avc.com/a_vc/2009/02/founder-dilution-how-much-is-normal.html)
- I don’t like complicated Angel terms, but it is fair to say that in the current market of mega IPOs and mega valuations there might be either a phenomenal exit or a few down rounds ahead of you. While I will not discuss whether the is or isn’t a bubble, your Angels might be insecure about getting on board. To eliminate this road-bump, VC Experts also has an article and example about dilution prevention for angels through warrants (http://vcexperts.com/vce/library/encyclopedia/documents_view.asp?document_id=1358).