Angel Investors and Valuing: Q&A

Angel investors usually value your companies differently than others, here are some Q&As relating to angel investors’ valuation techniques in Canada and in the US.

Valuation'”putting a value on a business ‘” is a difficult task even for professionals. The task is that much more daunting for nonprofessional investors, a subset of the investment universe that includes most angels. The more sophisticated angels have wrestled with the issue and come up with a solution: next-round pricing. This methodology may be best illuminated in question-and-answer format.

Q: How do you value a start-up in the angel round when there are no revenues, customers, nor complete management teams… just a concept and some intellectual property?

A: Increasingly, the answer is that you don’t. You value the company for the purposes of allocating percentage interests for a given amount of money on the basis of the next round, the so-called Series A round.

Q: Why postpone the valuation?

A: First, it’s very hard for angels, particularly angels who are not routinely involved in the venture capital business, to come to an intelligent estimate of valuation when so many factors are yet to be known or realized. Secondly, angels are often friends and family (the angel round is sometimes called the friends-and-family round), and there’s a natural reluctance to drive a hard bargain with a relative, a former college roommate, or the best man at your wedding.

Q: Is the price the same for the angel and the Series A round? Isn’t that a bit unfair to the angels?

A: Yes, it is. Therefore, the price is not the same. Ordinarily, the price per share of the angel round is stated as a price that’s discounted, say, 20 percent to 30 percent from the price in the Series A round. The reason for that is to reward the early ‘” and highest-risk ‘” money.

Q: What happens if there is no Series A round?

A: There is a default option ‘” a penalty price, in effect. The start-up is given the opportunity to give the angels their money back, which is usually impossible, or issue shares at a low valuation (at below market prices), meaning maximum dilution to the existing shareholders.

Q: If you use this methodology, what kind of security do the angels get?

A: It’s ordinarily styled as a bridge loan, convertible into common stock, or sometimes convertible into preferred stock at the same price or ‘” in the case of preferred stock'”entailing the same conversion price as the VCs pay in the Series A round.