www.paulgraham.com/angelinvesting.html
I put it off because it seemed mysterious and complicated. It turns out to be easier than I expected, and also more interesting. The part I thought was hard, the mechanics of investing, really isn't. You'll probably get either preferred stock, which means stock with extra rights like getting your money back first in a sale, or convertible debt, which means (on paper) you're lending the company money, and the debt converts to stock at the next sufficiently big funding round.
Don't spend much time worrying about the details of deal terms, especially when you first start angel investing. When you hear people talking about a successful angel investor, they're not saying "He got a 4x liquidation preference." That is so much more important than anything else that I worry I'm misleading you by even talking about other things. Mechanics Angel investors often syndicate deals, which means they join together to invest on the same terms. In a syndicate there is usually a "lead" investor who negotiates the terms with the startup. But not always: sometimes the startup cobbles together a syndicate of investors who approach them independently, and the startup's lawyer supplies the paperwork. The easiest way to get started in angel investing is to find a friend who already does it, and try to get included in his syndicates.
series AA documents Wilson Sonsini and Y Combinator published online. You should of course have your lawyer review everything. But the lawyers don't have to create the agreement from scratch.
If the company raises more money later, the new investor will take a chunk of the company away from all the existing shareholders just as you did. If in the next round they sell 10% of the company to a new investor, your 476% will be reduced to 428%. What saves you from being mistreated in future rounds, usually, is that you're in the same boat as the founders. They can't dilute you without diluting themselves just as much.
That varies enormously, from $10,000 to hundreds of thousands or in rare cases even millions. The upper bound is obviously the total amount the founders want to raise. The lower bound is 5-10% of the total or $10,000, whichever is greater. A typical angel round these days might be $150,000 raised from 5 people. For angel rounds it's rare to see a valuation lower than half a million or higher than 4 or 5 million. If you're part of a round led by someone else, that problem is solved for you. There is no rational way to value an early stage startup. The valuation reflects nothing more than the strength of the company's bargaining position. If they really want you, either because they desperately need money, or you're someone who can help them a lot, they'll let you invest at a low valuation. The startup may not have any more idea what the number should be than you do.
What you should spend your time thinking about is whether the company is good. Just make sure that you and the startup agree in advance about roughly how much you'll do for them. Really hot companies sometimes have high standards for angels. The ones everyone wants to invest in practically audition investors, and only take money from people who are famous and/or will work hard for them. But don't feel like you have to put in a lot of time or you won't get to invest in any good startups. There is a surprising lack of correlation between how hot a deal a startup is and how well it ends up doing. Lots of hot startups will end up failing, and lots of startups no one likes will end up succeeding. And the latter are so desperate for money that they'll take it from anyone at a low valuation.
The part of angel investing that has most effect on your returns, picking the right companies, is also the hardest. So you should practically ignore (or more precisely, archive, in the Gmail sense) everything I've told you so far. You may need to refer to it at some point, but it is not the central issue. What "Make something people want" is for startups, "Pick the right startups" is for investors. Combined they yield "Pick the startups that will make something people want." It's not as simple as picking startups that are already making something wildly popular. As an angel, you have to pick startups before they've got a hit--either because they've made something great but users don't realize it yet, like Google early on, or because they're still an iteration or two away from the big hit, like Paypal when they were making software for transferring money between PDAs. To be a good angel investor, you have to be a good judge of potential. They just try to notice quickly when something already is winning.
If you can recognize good startup founders by empathizing with them--if you both resonate at the same frequency--then you may already be a better startup picker than the median professional VC.
My extra year of experience was rounding error compared to our ability to empathize with founders. If there were a word that meant the opposite of hapless, that would be the one. They may be smart, or not, but somehow events overwhelm them and they get discouraged and give up. Which is not to say they force things to happen in a predefined way. That's the closest I can get to the opposite of hapless. You want to fund people who are relentlessly resourceful. Notice we started out talking about things, and now we're talking about people. There is an ongoing debate between investors which is more important, the people, or the idea--or more precisely, the market. Some, like Ron Conway, say it's the people--that the idea will change, but the people are the foundation of the company. Whereas Marc Andreessen says he'd back ok founders in a hot market over great founders in a bad one.
Bill Gates would probably have ended up pretty rich even if IBM hadn't happened to drop the PC standard in his lap. I've thought a lot about the disagreement between the investors who prefer to bet on people and those who prefer to bet on markets. The three most prominent people I know who favor markets are Marc, Jawed Karim, and Joe Kraus. And all three of them, in their own startups, basically flew into a thermal: they hit a market growing so fast that it was all they could do to keep up with it. Plus I think they underestimate themselves: they think back to how easy it felt to ride that huge thermal upward, and they think "anyone could have done it." So as an angel investor I think you want to go with Ron Conway and bet on people. Thermals happen, yes, but no one can predict them--not even the founders, and certainly not you as an investor. And only good people can ride the thermals if they hit them anyway. Deal Flow Of course the question of how to choose startups presumes you have startups to choose between. This is yet another problem that gets solved for you by syndicates. If you tag along on a friend's investments, you don't have to find startups. The problem is not finding startups, exactly, but finding a stream of reasonably high quality ones. If you're friends with a lot of investors and founders, they'll send deals your way. And once you start to become known as reliable, useful investor, people will refer lots of deals to you. There's also a newer way to find startups, which is to come to events like Y Combinator's Demo Day, where a batch of newly created startups presents to investors all at once. We have two Demo Days a year, one in March and one in August. But events like Demo Day only account for a fraction of matches between startups and investors. So if you want to hear about new startups, the best way to do it is to get lots of referrals. The best way to get lots of referrals is to invest in startups. No matter how smart and nice you seem, insiders will be reluctant to send you referrals until you've proven yourself by doing a couple investments. Some smart, nice guys turn out to be flaky, high-maintenance investors. But once you prove yourself as a good investor, the deal flow, as they call it, will increase rapidly in both quality and quantity. At the extreme, for someone like Ron Conway, it is basically identical with the deal flow of the whole Valley. So if you want to invest seriously, the way to...
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