The first important step in angel investing is doing thorough research on the kind of deals on the table. While angel investors play a crucial role by providing financial support and guidance to early-stage companies, investing in startups is a complex business.
After deciding to pursue an investment, one must look at the different structures and choose the most appropriate one because there is no one structure that will fit all the deals.
As choosing the right structure will depend on specific circumstances of each deal, here are some common deal structures that investors adopt.
The most common form of startup investment is equity investment where investors acquire a stake in the company in exchange for capital. This type of investment is usually in the form of preferred stock, which gives the investor certain rights and benefits over common stockholders, such as the right to receive a higher return on investment or priority in the event of a liquidity event. The equity investment structure allows angel investors to share in the success of the company and participate in its growth, which can result in significant returns.
Convertible debt is another popular investment structure where the investor provides a loan to the company, knowing it can be converted into equity in the future. Last year, the government extended the timeline for startups to convert debt investments into equity shares up to ten years.
Most of the time, investors resort to this structure when investing in early- stage startups that are still figuring out the business model. For startups, convertible debt provides an option for the company to raise capital without having to issue equity immediately. The conversion rate is usually set at a discount to the next equity round, which provides an incentive for the investor to convert the debt into equity.
Revenue-based financing (RBF)
Revenue-based financing (RBF) is a type of alternative financing that has gained popularity in the Indian startup ecosystem. It is a financing option that provides startups with a source of capital based on a percentage of their monthly revenue.
Here, investors provide capital to startups in exchange for a percentage of their monthly revenue for a predetermined period of time, after which the investment is fully repaid. Unlike traditional debt financing, the amount of capital that the startup must repay each month is tied directly to the amount of revenue it generates, making RBF a flexible and scalable financing option for Indian startups.
RBF is well-suited for Indian startups that have a proven business model and a stable revenue stream but may not meet the requirements for traditional debt financing, such as having a large amount of assets, a long operating history, or a strong credit rating.
iSAFE (India Simple Agreement for Future Equity) is a hybrid instrument that combines the features of both equity and debt financing, making it a popular financing option. This structure was developed by Silicon Valley-based accelerator Y-Combinator as SAFE and now adapted to India.
Here, the investor becomes an iSafe Notes holder after making cash investment to purchase shares priced at a future round. It gets automatically converted into equity shares in two different scenarios whichever happens earlier: in the event of liquidity events such as a next pricing or valuation round, dissolution, merger or acquisition or at the end of three years from the date of issue.
Although it may appear similar to a convertible debt, an iSafe note is a convertible security and does not accrue interest.
Despite many options available, investors must always consider the safest and most efficient way to invest in startups before shaking their hands on any deal.
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