From Feld Thoughts: Best structure for a Pre-VC Investment?
Assuming that you are planning on raising VC money some time in the future, there are two different typical structures for the first angel financing: (1) convertible debt and (2) preferred equity.
Convertible Debt: This is the easier approach of the two. In this case, the investment is in the form of a promissory note that converts into equity on the terms of a “qualified financing” (where qualified financing typically is defined by having a minimum amount – say $1m of total investment.) The note will either convert at a discount to the price of the qualified financing (usually in the 20% – 40% range), will have warrant coverage (usually in the 20% to 40% range), or both. This discount and/or warrant coverage gives the angel investors some additional ownership in exchange for taking the early risk. This note should be a real promissory note with the conversion and redemption characteristics clearly defined to protect both the investors and the entrepreneurs from any misunderstandings.Preferred Equity: This is also known as a “light Series A” – it’s preferred stock that is similar to that a VC will get, but usually with lighter terms due to the relatively low valuation associated with it. For a very young company, a $500k investment can receive between 25% and 50% of the equity in the company and, as a result, many of the terms associated with a typical VC investment are overkill.
From Redeye VC: Bridge Loans vs. Preferred Equity
an entrepreneur wants a seed-investor who can add real value, it is not productive to economically penalize that investor when they add it. Structuring a seed-round as equity allows the investor and entrepreneur to be completely aligned and share one goal - to create as much value as possible for the company.