Need Advice on Pre-Seed/Angel Opportunity
TLDR: I would greatly appreciate help on following topics:
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For pre-seed/angel round financing --- anything before institutional money --- is SAFE or convertible notes safer from an investor's perspective? The founder is proposing SAFE, but I am not very comfortable with the concept.
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What percent of equity should I aim for in this round of financing? The founder is proposing [50K] USD for somewhere between 1-2% of his company under a SAFE agreement.
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What terms should I include when drafting the contract? For example, any particular milestones related to product/MVP development, total contract value in X months, etc. I believe I should ask for a board seat. Will a board seat at this stage be unusual (for this kind of companies)?
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Anything else I should be aware of? I do not feel very comfortable leaving everything to a generic contract/frame provided by Y Combinator.
Hi all, I now have an opportunity to do an early-stage investment in a biotech startup that does business in computer-aided drug discovery ("CADD"). This is more of a software thing that gets applied in the drug-discovery/biotech world, very different from an innovative drug biotech company.
Having talked to the founder multiple times and done extensive research on the industry and technology, I am seriously thinking about investing a good amount of money --- from my own perspective, I am aware that there are a lot of rich people on this forum --- in the nascent startup that is founded by a long-time acquaintance/friend of mine. We knew each other back in college when he was a Ph.D. and I was an undergrad.
What I think of this industry and his startup
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I think CADD is an irreversible trend. I believe in the thesis that "faster computers and better algorithms will accelerate XXX processes, cut expenses, and produce more and better drugs for consumers".
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However, I do not think CADD as an industry will be profitable in the near future, let's say the next three years. I think it will be more mature after maybe 5 years. This will be a long bet.
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My friend is an honest, hard-working guy. I am 200% sure that he will not waste any investor capital intentionally. On the other hand, I do not have full grasp on his algorithm either. He is confident that his source code, written in Python (my experience with coding is sophomore CS major level, probably closer to a junior), will match market-leading algorithms such as Schrodinger's. He plans to charge a lower cost to enter the market. We have not officially talked about giving me access to part of or all of his source code yet, but I think that will be an essential step in my due diligence. Or is asking for source code access rather abnormal?
4. An ex-coworker of him is now starting a competitor company and has secured $10 million in financing. Founder thinks he has meaningfully better technology, but Founder is not very well-versed in capital markets and I have a feeling that if I go above 5%, he will be very reluctant. Let's say I contribute 50K, total capital pool is now roughly 200K-250K --- my capital contribution will be somewhere between 20% and 25%.
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From a revenue's perspective, no signed contracts yet. There are some prospective orders in the pipeline. He has just formed a corporate entity. His code is roughly 85% complete, expecting to finish late April.
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He would like me to be onboard as a fractional/part-time CFO and then help secure an institutional round later on. We have not talked about a precise timeline yet, but it will be in the next 6-12 months ballpark. This is not related to my prospective investment, but there will be more share awards if I successfully pull off the gig. I want to provide this part as background info, but this will NOT be related to a prospective investment.
I Am Seek Help Regarding To:
See the first section.
I know this is a long read, but I hope people on this forum could find it interesting also. Thank you all in advance for your patience and generosity.
Based on the most helpful WSO content regarding early-stage investments, here's a comprehensive breakdown to address your concerns:
SAFE vs. Convertible Notes for Pre-Seed/Angel Financing:
Equity Percentage for a $50K Investment:
Key Terms for the Contract:
Additional Considerations:
In summary, while SAFEs offer simplicity, convertible notes might provide more protection and upside potential for investors. Negotiating the right equity percentage and including specific terms in the contract can help safeguard your investment while supporting the startup's growth. Conducting thorough due diligence, including technological assessment, and understanding the competitive landscape are crucial steps before finalizing your investment.
Sources: Venture Capital Associate Fielding Questions, What to expect at VC interview?, Want to build a startup & raise some money? Part II, Difference between late stage VC and growth equity, Want to build a startup & raise some money? Part I
bump
Having been on both sides of this equation, ask yourself the following questions before proceeding on deal teams, diligence, etc.
1. If I lose this money, will this negatively impact my relationship with this person? -- You're almost certain to lose some if not all your money on this venture
2. How involved do I want to get in this venture? -- You mention board seat, fractional CFO, etc., neither of those are necessary for a pre-product pre-seed company
3. Why do they need money now? What's he going to use it for? -- You mentioned they're raising $200-$250K, are you the largest check? Why are the others investing? This will play into valuation.
You need to then align with then on these expectations since you're tied together for the long-term and you want to start off on the right foot.
Comments on your questions below:
For pre-seed/angel round financing --- anything before institutional money --- is SAFE or convertible notes safer from an investor's perspective? The founder is proposing SAFE, but I am not very comfortable with the concept.
SAFE is pretty standard. You can opp for a capped SAFE (post-money valuation) with a discount in order to get decent terms. A priced round requires legal and isn't worth it for small, early rounds.
What percent of equity should I aim for in this round of financing? The founder is proposing [50K] USD for somewhere between 1-2% of his company under a SAFE agreement.
Whatever they're willing to give you, but it's typically expressed as a pre-money and post-money valuation. e.g. 1% of the company for $50K would be a pre-money valuation of $5M and a post-money valuation of $5.05M (assuming you're the only money in this round).
What terms should I include when drafting the contract? For example, any particular milestones related to product/MVP development, total contract value in X months, etc. I believe I should ask for a board seat. Will a board seat at this stage be unusual (for this kind of companies)?
No board seat. You can ask for information rights but if I were him I'd say no. You shouldn't be adding structure at this stage.
Anything else I should be aware of? I do not feel very comfortable leaving everything to a generic contract/frame provided by Y Combinator.
If you want to have a lawyer draft something up for you, go for it. I've made half of dozen angel investments on the YC SAFE and had 20+ investors invest in my company using it as well. That said, I wasn't the only investor in any of these companies.
is asking for source code access rather abnormal?
Are you under NDA? Reviewing the source code is a weird ask, especially since it doesn't sound like you're capable of evaluating it yourself.
My advice -- Don't pump $50K into one angel investment if you've never done it before. Start smaller and if they end up raising another round you can add more at a higher valuation but relatively lower risk profile.
OP here. Very helpful. Thanks a lot.
On a second thought, one question regarding information rights: why can't investors ask for this? Isn't this a very basic right? Otherwise, investors could be putting their money in a hole without even knowing it.
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