
How to Be an Angel Investor - sama
http://www.paulgraham.com/angelinvesting.html
======
pg
I recommend founders read this too. It would be useful to them to imagine how
things look from the investors' side. I'm surprised more didn't take advantage
of the Justin.tv stream to spy on the investors at AngelConf. They were pretty
candid about how they think.

~~~
sam_in_nyc
I was looking through the legal documents just to get a sense of what
technically happens when a corporation issues a new type of stock. Thanks for
sharing these documents.

Not sure if this is relevant, but <http://ycombinator.com/seriesaa/aa-
boardconsent.doc> has a typo... there is no section 1.iii .. it skips to
1.iiii and then 1.iv.

~~~
andreyf
You mean section 1.iii is misspelled as 1.iiii

~~~
sam_in_nyc
Yes, exactly.

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adamsmith
I thought this was an interesting claim:

> Angels are the limiting reagent in startup formation.

I'd like to claim that I would have started startups even if YC didn't accept
Xobni for the summer of 2006 class. I had already failed at a half-startup. I
was doing consulting for another startup called Siteadvisor. Etc.

Yet YC was the catalyst for dropping out of grad school.

Paul certainly gets a unique view into startup creation. I just wonder what
the second and third order terms are of this equation.

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iamelgringo
_There probably aren't more than a couple hundred serious angels in the whole
Valley, and yet they're probably the single most important ingredient in
making the Valley what it is. Angels are the limiting reagent in startup
formation.

If there are only a couple hundred serious angels in the Valley, then by
deciding to become one you could single-handedly make the pipeline for
startups in Silicon Valley significantly wider. That is kind of mind-blowing._

Wow. Mind blowing, but a great insight. I'm really amazed at how few Angels
there are, and what a huge disproportionate influence they have on the world
economy.

Personally, I think that angel investing would be an absolute blast. Just got
to get that, "rich" bit figured out so I can start doing angel investing. :)

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sachinag
The best part about this - Paul calls out the lawyers you should use. Thank
you, thank you, thank you a thousand times for this. (We got standard
corporate attorneys - I've spent almost $60,000 on legal expenses between
incorporation, option plan, and IP protection. Probably could have done it all
for under $20K with the right attorney from the get-go.)

I would love to see a sample convertible debt document in addition to the
Series AA documents.

~~~
tptacek
$60k on incorporation, option plan, and IP?

You know more about this stuff than I do, but that sounds crazy high. Is the
breakdown like, 10%/80%/10%? The one of these that I can see spending money on
is the option plan.

~~~
sachinag
10/10/40. I got bad advice. Everything's overbuilt because our guy, even
though he's a member of the IVCA, didn't have standard docs.

~~~
tptacek
If $24k for IP is bad advice, what do you think the right number would have
been?

~~~
sachinag
Yokum (one of the absolute best out there) quotes $5K as a barebones starter
package. I'm sure he'd have helped us avoid overbuilding on the IP in addition
to the overbuilding on the corporate stuff.

<http://www.startupcompanylawyer.com/faqs/>

I refuse to believe you could get half as good as Yokum for twice the price.

~~~
tptacek
He wouldn't remember it, but Yokum spent a good chunk of time on the phone
with me and my cofounders when we started Matasano, as a favor for a mutual
friend. I totally agree with you.

Having said that, I guess I was weaseling my way around to the point that a
boilerplate IP agreement would cost next to nothing, and would probably be all
you'd ever need. People obsess too much about IP, and not enough about their
own execution risk.

~~~
sachinag
(I know it's uncool to say here, but we're applying for a patent on our
transaction engine. Even in the patent process, we probably could have saved
some cash.)

~~~
tptacek
Uncool isn't the word I'd use. I've got patent applications from 7+ years ago,
with reputable IP lawyers working for going concerns, that are still
"pending". My snipe at you might be "pointlessness". ;)

~~~
tptacek
(but I can see why you spent so much money on IP now; patents are expensive).

~~~
sachinag
Chicago investors kept telling me they would only invest in a company with
"protectable IP." Coming from a healthcare VC background, I didn't question
it. That was a mistake.

It is what it is at this point - so much money sunk into it that I want to
finish it off.

~~~
tptacek
The alternative approach to this is trade secrets law --- we've advised
trading firms (for instance) that go through some formality to demonstrate
controls on trade secret information for exactly this reason. But you'd
probably have been screwed on lawyers either way.

Best of luck with the project.

------
gcheong
_(you probably shouldn't try angel investing unless you think of yourself as
rich)_

I think there is some legal definition of "rich" below which companies can't
raise capital from individuals without issuing registered stock. Something
like an individual must have at least $1m in assets or income of at least
$200k/year I think.

~~~
tptacek
You're thinking of the SEC "accredited investor" rule:

<http://www.law.uc.edu/CCL/33ActRls/rule501.html>

I'm not an investor and have only moderate experience with funding, but I've
brought this up in lots of HN threads about investing and haven't seen it shot
down; I was also involved in a negotiation debacle that doubled the value of
some options I held in a company that sold to another private company (I had
left, had non-expiring options, and would thus have been a non-qualified
outside investor had I exercised them, or some-such).

The rule is basically: $1MM net, or $200k ($300k with your spouse) income for
the last 2 years.

Even corporations need to be accredited to buy, so you can't just start a
consultancy and invest your profits into angel syndicates, unless the
principals are themselves accredited or the business has a such a huge amount
of net assets that the principals would certainly be accredited anyways.

Again, I feel weird every time I bring this up, because what do I know? But
this appears to be the rule.

~~~
frig
Yeah, it's the rule, and it's relevant but not in the obvious way (like: you
wake up at night and the SEC has kicked down your door and shot your dog b/c
you're not an accredited investor but have investments that they think you
need to be in order to make).

The origins of the rule were partially in reaction to various scams that were
not uncommon pre-great-depression: people would go around selling shares
("music-man" style) in companies that didn't exist, or were otherwise
fraudulent, etc., to unsuspecting dupes (of which there were plenty, as is
always the case).

Thus the effect of the rule is mostly on the issuer of securities: the point
was mostly to deter scammers, but not really to punish their victims.
Currently, there are many categories of investment that either are 100% closed
off to non-accredited investors or that "theoretically" are not closed off but
are "practically" closed off (eg b/c the additional regulatory overhead and
legal uncertainty and "bad juju" induced by having non-accredited investors as
shareholders means no one sensible would willingly allow non-accredited
investors to invest).

Hence your experience: it's not "illegal" for _you_ to be a non-accredited
investor in a private company, but unless all the i's are dotted and t's
crossed the private company might be in a bad way wrt regulation on account of
having you as an investor (inadequate documentation of your informed consent,
or failure to keep enough bookkeeping, etc.). Moreover, even if they were
doing everything 100% correct wrt you the presence of your investment might
scare off other parties (eg during due diligence for a round of funding).

As a regulatory rule it's accomplished it's ostensible purpose -- the # of
outright-fraudulent investment schemes is nothing like it was in the 20s, and
the direct impact of the remaining schemes is mainly felt by those that mostly
can afford the loss and ought to have known better (eg: Madoff's or Stanford's
clients).

One thing I'd like to see is some kind of relaxation in the accredited-
investor regulations that'd make it easier for the smaller investor to make
direct investments in private companies. This needn't be difficult to
implement, as all it might take is eg a standardized waiver process that
records: the terms of the investment, the investor's consent to the agreement,
and lots of identifying information on the issuer (firm and specific
individual making the offering); if necessary, restrict the sophistication of
the allowed instruments (eg: direct equity purchase, simple options, and so on
are ok; anything more complicated not ok for the "standard waiver").

Sadly I've not seen much mention of "proposals" like the above, but something
like that would (I think) really open a lot of productive opportunities for a
lot of people.

Edit: this section is interesting reading:

<http://www.sec.gov/info/smallbus/qasbsec.htm#eod6>

It's an informal discussion of various ways to sell securities in a private
company. The interesting parts are:

(1) the motivations behind the exemptions (eg: the intrastate rule; given the
point was (originally) to keep traveling hucksters from defrauding suckers,
the impetus for an exemption for a "local" business makes sense)

(2) even in this informal summary note just how easy it is to fall out of
grace wrt these "exemptions" (ie: if someone is supposed to buy "not for
resale" then resells, you personally might have a breach of contract with that
person but you might also now start worrying about being in breach of
regulations)

------
cperciva
_How much does an angel invest? ... The upper bound is obviously the total
amount the founders want to raise._

Obviously this is _an_ upper bound; but it isn't necessarily _the_ upper
bound. I'm sure there are instances where the limiting factor is how deep the
angel's pockets are.

~~~
davemc500hats
as a "private amateur" angel investor, i put ~$300K into 13 deals over a
period of 4 years ('04-'84(, at a median size of around $20K. my largest
investment was $100K; my smallest was $5K. most of them were at valuations
south of $3M (in a few cases i did A rounds north of $5M pre, however in both
cases i was working or consulting with the company). so far it looks like 3 of
the 13 will do >5x, another 2-3 are likely going to return 0, and the other
5-6 are still tbd. i'm hopefuly i'll end up with 3-5 wins, and an aggregate
return of 4-5x over a period of perhaps 7 years.

as a "professional" angel investor now for a VC fund, i typically invest
$50-$250K at valuations between $1-3M pre-money (however i'm new on the
professional side; only done 4 deals since December). too early to say on
either wins or returns, but i'm happy with the deals i've done so far.

i think most private angel investors (in Silicon Valley) who dabble do deals
at between $10K-25K. most professional angel investors in Silicon Valley who
do it as their primary profession invest between $25K-250K per deal.

your mileage may vary.

some angels may do deals as high as $500K - $2M, however those are select
cases. most times there are multiple angels syndicating.

~~~
davemc500hats
sorry that should be "over a period of 4 years ('04-'08)"

~~~
gojomo
FYI, in the first 2 hours you can edit your posts via the direct link to make
corrections like that. (And thanks for the great specifics in the grandparent
post.)

------
lionhearted
Paul - you're the man, thanks and gratitude from me and lots of people for
another essay. Learned some good stuff this time.

Also, did you write this one either Etherpad? I took a lot from watching you
write your last piece in Etherpad, so if that's available that'd be very cool.
Cheers.

~~~
pg
Not this one, unfortunately. I blew out the first draft the night before the
conference after getting 4 hours sleep the night before that, and I just
opened up vi and started typing. It's a good thing this was one I could write
in my sleep, because I practically did.

There are some others I wrote on Etherpad though, which we'll be able to see
animated versions of once they release playback.

------
sharpn
Good essay - and I also liked the video (posted earlier) that it was based on.
Tiny pedantic point; there's one too many 'should's here: "Similarly, founders
should also should not get hung up on deal terms" Either 'Similarly, founders
should also not...' or 'Similarly, founders also should not...' Didn't want to
detract from the message of the piece, but thought it worth pointing out in
case it helps.

~~~
pg
Thanks, fixed.

------
dreeves
I have a potentially silly question: When you buy stock in a public company
you have specific protection from liability -- the worst that can happen is
you lose your investment. As an angel investor the worst case is worse, in
theory. If the company racks up huge debt (maybe by getting sued) then you as
a part owner could be on the hook for that. Is that worth worrying about in
practice?

------
RPatershuk
Very Nice Work - and thnks for the contribution of docs.

Having read this from a founder point of view its clear to me that neither one
side or the other of the transaction has all of the answers. Kind of back to
the difference in meaning of "being offered terms", "being given terms" or (my
favorite) "coming to terms"

I'll echo the request for a convertable debt document template

------
penacu
Perhaps the single most pragmatic and understandable description of angel
investing I've read to date. I am courting angel investors currently and have
only run into a small handful who meet the criteria you describe.

Thank you so much for writing this.

Ted Ray, Founder & CEO, Ted's Tinctures Inc. <http://jetlagformula.com>

~~~
rms
Good luck with the fundraising!

I'm curious about your product though. I find it hard to believe that your
formula is more effective than 1-3mg of melatonin when the time comes to
sleep.

Is it the particular combination of ingredients that is so effective? It
doesn't seem like any of the individual ingredients would have much of an
impact. It doesn't mean you don't have a business model though, you have very
nice packaging and there is currently no package on the shelves that treat
jetlag.

It would complicate dosing instructions, but would not bundling your product
with 1mg of melatonin to take when it comes to sleep dramatically improve
effectiveness?

Edit: After reading the testimonials on your site, it seems that you are not
trying to (supplement) sleep cycle issues, but are dealing with the fatigue
and haziness one feels after flying for 18 hours. I would believe your product
helps with that.

------
msort
Several good hacks from the writing: 1) Be relentless resourceful. 2) Lower
your risk to be decisive. 3) Be good.

------
niels_olson
This essay and the associated talk happen to form a great object lesson in
writing: record some people talking and transcribe it yourself. You learn
complexities of human speech, proper use of punctuation, when to break the
rules, how unbelievably much people talk, all sorts of good things.

------
silvia77
I just finished typing out a transcript of the video on justin.tv. If your
interested, check it out at <http://tinyurl.com/d8tpzd>

------
physcab
Thank you for posting this. Is there a way I can view the Justin.Tv stream
again? Youtube?

Also, do angel investors ever go _looking_ for deals, or is this a sign of a
bad angel investor?

~~~
abstractbill
_Is there a way I can view the Justin.Tv stream again?_

It all gets archived:

<http://www.justin.tv/clip/15489851960ba5d5>

------
Paul_Johnson
The opposite of "hapless" is probably "lots of gumption".

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gunsgarg
well worded, well drafted article. I am currently a founder of a company which
took its first angel/seed investment from 5 investors, I could feel every word
thats beens said. If I ever make big - or "rich" as you say, I'll be looking
to contribute my small %age to the angel investing... Thanks Gunjan

------
Create
VC-s cut both ways: see Eric Brewer for the good and Ferguson (S.C.H. High
Stakes, No Prisoners) for the ugly.

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gcheong
Thanks for this, it really cleared up a lot of questions I had after watching
the livecast of the conference.

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ambition
"Good people find good markets."

Such an important point, and one with few resources for learning about.

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rqualls
You just rocked my world with this blog. Thanks!

Rachael Qualls Founder and CEO Angel Capital Group

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pruett
Brilliant post. Lots of great information from a rarely seen point of view.

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ctingom
Great article.

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eyaris
thank you.

