INTRODUCTION “Down-rounds” have become a critical challenge for angel investors. These are the declining valuations that often accompany the entry of new investors into subsequent financing rounds. In some cases, down- rounds are substantial enough to severely diminish or eliminate entirely the equity stake held by angels and other early investors. Angel investors are often quick to criticize venture capital investors (VCs) for down-rounds. However, angels who are careful about keeping their eye on the ball are much less likely to suffer heavily in down-rounds. VCs and angels may exhibit differences in approach and may be driven by different prerequisites. Nonetheless, the two have much in common. With better attention to detail and a better understanding of the VC process, angels can make early-stage investing a more congenial and rewarding experience. B RIDGING T HE G AP : H OW T HE P RUDENT A NGEL C AN S URVIVE T HE D OWN -R OUNDS by W. Daniel Mothersill C HAPTER 5
S U M M A R Y For many angel investors whose deals require subsequent financing from venture capitalists, declining valuations, or “down-rounds,” have become a major problem that, in some cases, sharply reduce or eliminate angels’ original equity stake. Angels can protect themselves against the impact of down-rounds by beginning with a realistic appraisal of the investment, monitoring their investment throughout the process, using such mechanisms as guaranteed payouts and management fees, formulating strong funding and defensive strategies, participating in subsequent financing rounds, and building better relationships with venture capitalists. Most of all, angel investors are advised to understand the motivation and behaviour of venture capitalists and have an exit strategy in place from the very beginning.
How does the prudent angel avoid getting burned in down-rounds? The primary rule of an angel investment – as with any investment — is to plan for one’s eventual exit. Angel investors need to consider their exit strategy from the outset, and continue to do so through the entire investment process to payout. Only the naïve will expect later-stage investors to look after their interests. THE INVESTMENT CLIMATE By the end of 2002 and into 2003, the environment for early-stage financing had become as discouraging as it has been for the past 25 years. Little money was being invested and fear tended to dominate investment decisions, making negotiations difficult and seriously reducing risktolerance.
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