Home / Angel Investor Negotiations / What To Offer Angel Investors: Equity Preferred Shares

what to offer angel investors: equity preferred shares

If you are a start-up business entrepreneur, or looking to expand your business, gathering funds would be your foremost concern. You need to know ways of engaging your investors in a fruitful manner. The relationship between you and your investor should be mutually fulfilling. It must be profitable for both and must be equally cherished and valued by the financer and the financed. Of course, at the end of the day, the base of the equation is primarily commercial. Therefore, you must always look at ways to ensure profits for your investors so that there is a constant inflow of funds. There are two steps towards ensuring a positive experience. First, you must select the right category of investors for your enterprise. Second, you should be able to prepare an offer for them, which is mutually beneficial.

Regarding the first aspect, angel investors must be preferred over venture capitalists for funding your ventures. Angel investors are known to be completely involved in the development of business processes and are known to provide expert guidance wherever necessary. They can sometimes prove crucial for the success of your business. When compared to venture capitalists, angel investors do have limited resources for financing projects. They are ideal for small projects or start-ups which require limited funding. For higher funding prospects, angel syndicates must be targeted. These syndicates are formed by a group of angel investors with common interests and are a good choice for a stable and long term investment, in the higher bracket.

Angel investors will definitely look at lucrative associations with your business venture. You can either engage them with equity common stock or equity preferred shares. Although you might want to offer them common shares, most investors will be most keen to acquire equity preferred shares of a company. There are substantial reasons for this as well. First, equity preferred shares are often associated with a fixed dividend and are a more profitable option when compared common stocks, which do not have fixed dividends, associated with them. Secondly, equity preferred share holders are given preference over common stock holders in the event of liquidation. Therefore, if you own equity preferred shares of a company, you stand a bright chance to recover your resources, in the event of sell-out or bankruptcy.

Third, equity preferred shares are convertible. You can convert them to common stocks, should you so desire. They are callable at the corporation’s option. However, equity preferred share holders do not enjoy voting rights, like common stock holders. Equity preferred shares may be cumulative or non cumulative in nature. In cumulative equity preferred shares, the unpaid dividends accumulate over a period of time and are to be compensated quarterly, half yearly or yearly. Equity preferred shares without this feature are called non cumulative equity preferred shares. Just like bonds, equity preferred shares are rated by eminent credit companies.

One must understand the implication of offering equity preferred shares to investors before doing so. The rights which they enjoy might have a significant impact on your business processes. You must study all the impacts, before deciding to offer them to your investors. First, there is the conversion issue, where equity preferred share holders can convert themselves to common stock holders as per a given ratio. The most common ratio at the outset is 1:1 when shares are issued. However, this might continue to change with every fresh round of financing.

Second, there is the anti-dilution provision associated with equity preferred shares and comes into play when shares are issued below the conversion price. This provision will discourage you to reduce share prices in future. The conversion price depends on the type of anti-dilution protection available. Basically there can be two types of protection made available. There is the Full Ratchet Protection which is favourable for equity preferred stock holders and there is the Weighted Average Protection which favours the entrepreneurs. Along with this there is the fixed dividend rights associated with equity preferred shares. This means that you are liable to pay a fixed annual return on the basic purchase price. Also, if the company faces liquidation, equity preferred stock holders need to be paid out first.

Sometimes equity preferred share holders may be conferred with blocking rights. This means that they would be enjoying the legal authority to stop vital financial proceedings of a company. They might be able to stop the liquidation or sell-off of a company, stop an equity financing venture or restrict the number of stock options etc. In certain isolated instances, equity preferred share holders might be able to stop or regulate major corporate governance decisions line appointing senior management staff, etc.

Therefore equity preferred share holders can have considerable impact on the important decision making processes of an organization. You need to understand the implications of the same, before offering shares to your investors. Deciding on the specific terms and conditions with investors is a tricky job. It is always better to make modest beginnings, when you offer rights and privileges to investors. Once you set the standards, you can never back track on them. An entrepreneur can never convince his future investors on less lucrative terms, because they would always compare themselves with past investors and want a better deal. You need to think twice before offering, therefore.

Although, common stocks will be a preferable option for you as a business owner, it will never be possible to do away with equity preferred shares completely. After the second and third round of financing, all angel investors could seriously demand equity preferred shares in exchange of funds. If you have engaged an angel syndicate, the demand could be even stronger than ever. Therefore, ideally you should know how to juggle between common and equity preferred shares and create a fruitful combination of the two. You should know when to offer which, and to whom. Ideally, investors should only be allowed to intrude up to a certain point in the regular functioning and decision making process of an organization. At no point should they be allowed to assume complete control.