2. Debt VS Equity

2. Debt VS Equity

It is now time to get to the heart of the matter and discuss the different investment structures that exist for Angel Investing - Debt and Equity.


The two most common forms of debt investment are convertible notes and BSA Air (Simple Agreement for Future Equity). Convertible notes and Air BSAs are the same thing with a few differences:

  • An Air BSA is simpler and faster to draft
  • The terms of an Air BSA are slightly friendlier to the founders than to the investors

In more technical terms, a convertible note is a loan that converts into equity if certain milestones in the life of the startup are reached, whereas a BSA is a right to buy equity at a certain price in a future round of financing.

In a convertible note investment, the investor makes a loan to the company (the debt), and this loan will convert into equity (shares) at a pre-determined time in the future, with some bonus for the investor having taken the risk of investing in the startup at an earlier (and therefore riskier) stage than investors in subsequent rounds of funding. The trigger for this conversion is usually a funding round where the value of the company is above a certain amount. Most often, the bonus mentioned is the possibility to acquire the equity (shares) at a lower price than the other investors in the financing round. Convertible notes also generate interest that is paid in the form of additional shares upon conversion.

The main reason why debt investments are simpler, quicker and cheaper (10% of the price of a conventional financing round) is that the question of valuation is not addressed and will only be defined in the subsequent financing round. There are fewer constraints which means less paperwork, less negotiation required, fewer hours billed by your lawyer and therefore more savings

In addition to the advantages mentioned above, postponing the valuation discussion is a good thing in itself. Indeed, defining a valuation for such a young company is more of an art than an exact science. In order to do so, it would be necessary to be able to evaluate intangible elements such as the intelligence of the founders or their motivation. A debt investment allows to postpone the (sometimes) difficult discussion of the valuation and above all, the latter will be based on more tangible elements since the company will have matured and will have more data to establish its current and future value.


In an equity financing round, the company offers newly created shares at a fixed price. Investors can then buy these shares, giving them an ownership interest equivalent to the percentage of shares they have purchased. Generally, there are two types or classes of shares: so-called "ordinary" shares and "preferred" shares. Common shares are the most basic and are usually owned by the founders and then by the employees in the case of a (now almost universal) employee stock plan. Preferred shares are most often owned by business angels and venture capitalists. These shares give access to additional rights including getting paid first in the event of an exit (buyout, IPO etc.), access to board seats, the right to reinvest in the future and access to detailed reports on the progress of the company (usually monthly reports sent to all investors).

In an equity financing round, it is necessary to establish the valuation of the company, for which there are two types of valuation, pre-money and post-money. Here is a simple example to understand the difference between these two terms:

Let's take a company raising €1m at a pre-money valuation of €10m. The post-money valuation is simply the established valuation of €10m plus the €1m now held by the company (1 + 10 = €11m). Investors calculate their ownership percentage on the post-money valuation. In our example, this represents 1/11 or about 9% of the company.

Important terms for the investment terms

Convertible notes and Air BSAs are legal documents that may seem daunting but in reality, only a few terms are really important to understand to ensure that the investment is fair to both founders and investors. Also bear in mind that as a business angel you are unlikely to continue to invest in subsequent rounds of funding and therefore in those subsequent rounds you will simply follow the terms negotiated by the new investors. These new investors are usually referred to as 'leads'. They are the ones who will negotiate the terms of the subsequent rounds of financing with the founders and once determined, other investors can join the financing round provided they accept the negotiated terms.

Valuation Cap

The best way to think about the valuation cap in a debt financing round is that the cap is the closest thing to a traditional valuation of the company. If you set this cap at €X, you are telling the startup that if they raise an equity round in the future at a valuation higher than €X, your investment will still convert to that €X valuation, ensuring that you get a corresponding level of equity and number of shares back. Setting this cap aligns your interests with those of the founders who will be seeking funding in the future. Why should you do this? Because if the company raises in the future at a very high valuation, this would imply a strong dilution of your equity and therefore owning a smaller share of the company. If you invest €20k in a company worth €1m you own 2% of that company. If the company is valued at €4m you will only own 0.5%.

Without a valuation cap, business angels may be discouraged by the idea that the company they are investing in will be valued higher in the future (although worth the same amount). Setting a cap allows these business angels to convert their equity to a valuation cap and therefore potentially value their investment at more than the amount invested. If you invest €20k at a cap of €1m and the company is well valued at €4m in the subsequent round, you will receive 2% which would value your investment at €80k.

In some very competitive investment opportunities, there may not be a valuation cap. This is the price to pay if it is an exceptional opportunity and the founders are looking to protect themselves from some uncertainty about their own dilution in the future. That said, if the opportunity is truly exceptional, it is better to join the venture than the other way around. As a general rule, it is understood that debt rounds without a valuation cap are not favourable to business angels.


The "Discount" rate allows the owners of the company (so you as a Business Angel) to buy newly created shares for a new investment round, at a lower price than the valuation established by this new investment round. This means that you can simply buy more shares for the same price. This reward comes because of the risk taken by the Business Angel who invested early in the life of the company.

For example, let's say a BA (Business Angel) puts €20k into a convertible note in the first round of investment (Seed) and the company then raises a subsequent round with a VC (Serie A). The price per share is €1. You receive a 20% discount (standard rate) as set out in the convertible agreement signed between the parties. This means you pay only €0.80 per share, giving you access to 25k shares for your €20k investment as opposed to the 20k shares you would have received if you had paid the same price as the Serie A investors.

If a convertible note has a discount rate and a valuation cap, you will exercise the option giving you access to the best deal (cheapest share).


Simply put, the pro-rata is what allows you to maintain your ownership level (percentage in shares) in subsequent rounds of financing. For example, if you own 2% of a company after their seed round, and the company raises a Serie A at a valuation of €10M, you are entitled to invest more money to maintain your 2% level. In this case, €200k. This option is important because it allows you to avoid too much dilution and thus gives you the choice to over-invest in the most promising companies.