It is time to bring together all the elements reviewed in the previous chapters around a concrete example
You are a Business Angel leading a syndicate for a company raising €750k in pre-seed through a convertible note. A VC specialising in pre-seed, Mika Ventures, leads the round and puts in €500k. The syndicate you lead invests €100k, €10k from you personally and €90k from other business angels who trust you. The rest of the round, i.e. €150k, is completed by independent business angels.
As Mika Ventures leads the round, they set up the terms of the convertible note. You sign this note with the following terms.
- 4m€ cap
- 20% discount
- All investors get preferential shares on conversion to equity (including pro rata rights)
- The note will convert to preferred equity if the company raises a follow-on round of at least €1m
A year later, the company raises funds again in a seed round led by Seed Capital, a specialist fund. The round raised €3m at a pre-money valuation of €14m. The post-money valuation is therefore €17m (pre-money + amount raised). Seed Capital's terms include a provision giving them and the convertible note holder preferential shares in the financing. This round triggers the convertible note conversion event, turning the debt into equity.
Your syndicate therefore converts €100k into preference shares. You can choose to convert using the €4m cap or a 20% discount on the €14m pre-money valuation of €11.2m. Obviously, you choose the €4m cap because it means that your €100k gives you access to more preference shares and therefore a larger percentage of the company's equity. Dividing €100k by the €4m cap gives you 2.5%. In other words, your €100k is now worth €350k (2.5% of the pre-money valuation of €14m). Note also that this conversion usually takes place before the subsequent round, this is usually stated in the terms, which means that your syndicate enters the next round with 2.5% of the capital at the time of the additional €3m injection.
Should you wish to exercise your pro-rata rights prior to the round, you will be entitled to invest up to 2.5% of that round i.e. €75k (2.5% of €3m). Note here that the majority of angels do not exercise this right so in this example we assume that you do not exercise it either.
Let's go back to the example of the syndicate which converts its 2.5% of the capital to a valuation of €14m pre-money, i.e. €350k. Then the €3m round is executed without exercising the pro-rata clause. By dividing your capital by the post-money valuation (350k€ divided by 17m€), you obtain your new percentage, i.e. 2.05% of the company's capital. The dilution has taken place!
Two years later, things continue to go well for the company, which raises a Series A round with Serie A Capital as lead fund on the round. The Series A is for €8m at a pre-money valuation of €30m (€38m post-money). Serie A Capital is receiving a new class of preference shares, so although investors in previous rounds also have preference shares, these are more senior shares and therefore have more rights.
With this round, your 2.05% equity stake is now worth €615k (2.05% of the pre-money valuation). Because of your pro-rata, you are entitled to invest 2.05% of the €8m round, i.e. €164k. Again, you don't do this. This gives you €615k at a post-money valuation of €38m, or 1.6%. So note that despite further dilution, the initial investment has a value of 6.15x.
Scenario 1: Everyone loses
Here things are simple, the company does not manage to reach its objectives, the employees are unhappy and resign, the founders do not manage to make money again, they close the company. In this case, all the investors lose their investment, i.e. €100k for your syndicate.
Scenario 2: A few people lose
The company is running out of money and things are getting pretty desperate so the investors decide to sell the intellectual property developed by the company. The buyer puts €5m on the table to buy back this IP and the company is now in a position where it has raised over the years €11m and is only sold for €5m.
Because the company is selling for less than the full amount raised, only the senior preference shares (i.e. those of Serie A Capital) are eligible for a return on investment. The whole of the €5m therefore goes to them at the expense of all other share classes, namely yours (preference) and the common (founders and employees). Your union has therefore lost €100k.
Scenario **3: Everybody wins!
The company does not raise any money after its A series and is sold for €200m a few years later. As the company sells for more than the amount raised so far, the shares of all shareholders become common. Your syndicate owns 1.6% of the company, and therefore 1.6% of €200m, i.e. €3.2m, which implies a multiple of 32 of your initial investment. Let's go into more detail:
- Total profit of the syndicate: €3.2m (x32)
- Your investment of €10k becomes €320k
- Your syndicate having invested €90k, shares €2.88m in profit
- As the lead of your syndicate, you also receive a 15% carried interest on the syndicate's profits (€2.88m) which is €432k
In the end, your €10k investment turns into €752k 😎
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