This past Friday morning, there was a news story in which Brian Taffora of CSA Partners in Milwaukee criticized local angel groups for, in his words, "offering terms to startups that "de-risk" the deals for themselves but hurt the company's' longer-term prospects."
I couldn't agree more.
In most cases, the usual scenario is to insist, as an investor, on a guaranteed absolute $ return, regardless of the company's success. This translates into a situation where, even though the investor owned, say 20% of the company, they'd be entitled to a lot more than that if the company is sold for less than the entrepreneur "predicted." When the next investor comes along to invest as the company grows, they're unwilling to either fight with the angels -- or to invest and accept these ridiculous terms. So they walk away. And unless the investor is willing to fund all of the company's need for future investments, they've killed the deal for themselves as well as for the entrepreneur.
This approach tries to burden the entrepreneur with all of the risks inherent in early stage investing, and substitutes corporate thinking and financial engineering for doing any real sort of work to understand a business' prospects.
(It's also a good reason for investors to focus on expertise they have rather than trying to assume they can invest in anything.)
This sort of investing practice also has the potential to send good opportunities elsewhere looking for investors.
There are all kinds of mechanisms for accounting for risk. At the early stages it's primarily setting a value based on other transactions and similar circumstances. Simple, honest terms that have no hidden incentives and create no unintended consequences are a requirement. None of this is new news. If you've been doing this for a long time, it's all pretty transparent and there are lots of sources of standard terms, agreements and information about other transactions.
Our group - Golden Angels Investors - evolved from an organization originally formed to support and mentor entrepreneurs at the University level. We think simple, fair deals work best for everyone. And if we don't have subject matter experts, we help the entrepreneur go find them. Among its 100 or so members are plenty of entrepreneurs who understand the struggles and the challenges and how a relationship based on trust and understanding beats clever terms every time.