The Importance of Structuring
As I continue reading Winning Angels – the 7 fundamentals of early stage investing by David Amis and Howard Stevenson, I realize what a novice I am to investing and investments. In the last section, the book was on valuing the idea or business. This week’s reading was on structuring. The importance of structure really depends on the investor. Some investors play an active role in the structure of the deal actively leading the negotiation, some do not play an active part but just don’t invest if they don’t like the terms. On the flip side, some investors feel that the structure is irrelevant. They accept that the deal will either be a success or a failure.
There are three fundamental structures common to investing. These include: common Stock, preferred convertible with various terms, and convertible note with various terms. With each of these structures, you should look at the exit possibility, protection, and possible outcomes.
Common Stock is the easiest structure. This structure is used for family and friends. The book also says it is also used by fools. The structure allows the entrepreneur to issue stock according to the valuation agreed upon by the investor. An advantage to the use of common stock is the timeliness and the lack of additional risk. Some of the disadvantages are the possibility of loss of all your money, the entrepreneur could sell their shares to another person, or the company could completely fail leaving the investor with their shareholder’s equity position. This structure is great for the investor that is looking for easy and quick. It is suggested that the investor get the pre-emptive and tag-along rights.
Preferred Convertible is just that, preferred by some investors. This structure is not as simple as common. It requires more interaction with the entrepreneur. The preferred share structure offers more protection to the investor. The entrepreneur may expect more consideration for using this structure.
Convertible Notes with various terms are being used more often. Most of the risk is taken away with this structure. Convertible notes are debt instruments that allow the investor to turn their investment into stock. This structure can be more complicated and more time consuming.
A winning angel may use a variety of structures for different deals depending on the complexity, the amount of capital requested, the time-frame, and the trust they have in the entrepreneur. As a novice, I will continue to read Winning Angels.
Amis, David, and Howard H. Stevenson. Winning Angels: the Seven Fundamentals of Early-Stage Investing. Financial Times Prentice Hall, 2001.