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Basics of Investing in Startups



Are you thinking about investing in a startup company for the first time? If so, such topics as preferred stock, convertible notes, and dilution might sound like startup hocus pocus, but you’ll want to know what they’re all about.

In this post, I provide an introduction to several concepts that you should understand before entrusting your hard-earned cash to the founders of what might — or might not — be the next great thing. This post is a basic introduction to angel investing, which covers concepts common to most angel investments.


Startup investments are speculative and illiquid

True to my lawyerly training, I’ll start with the warnings: The first thing to know about investments in startup companies is that they are speculative. Many startup companies fail. This is true of those that gain early traction and successfully raise money from angel investors and venture capital firms, as well as those that don’t. When such enterprises fail, people who’ve invested in them can expect to lose much or all of their investments. So you probably don’t want to invest the kids’ college fund in startups.

Although angel investors can put themselves in a better position by conducting appropriate due diligence before investing, risk is in the very nature of early stage growth companies.

Even if a startup company doesn’t fail, investors might not see their money again for a very long time. Investors typically get money out of companies they invest in through dividends, sale of stock in a public offering, and sale of stock in the private sale of the company. High-growth startups (i.e., the type of companies that tend to attract investments) basically don’t pay dividends. That leaves stock sales as the most common avenue available for investors to see a return on their investments. Even in successful startups, sales of stock via IPOs and private company sales tend to take place only after a lengthy period of growth, and the investors’ money will be tied up in the interim. In the meantime, investors may not be permitted to sell their stock on their own — assuming they can find a willing purchaser.

A number of companies don’t really fail but they don’t really succeed either. This leaves investors’ money tied up indefinitely as the companies soldier on — not doing so badly to cause them to shut down, but not doing well enough to return money to their investors either.

Everyone who has built a business or put a business deal together knows that things generally take longer, are more expensive, and are more complicated than you would expect them to be. This is true of startup business plan execution, also. Even assumptions that seem to be conservative often turn out to be optimistic in retrospect.

High-growth startups are designed to be fed cash. The need for future cash is baked into the business plan of most of them. For example, if execution of a business plan would require $10 million before the company could be sustained by cash from operations, the founders might put in $100,000 of cash from savings, friends, and family; go to angel investors for the next significant infusion of cash; and rely on one or more rounds of venture capital investments to make it to profitability and to roll out the concept on a larger scale. At each round of financing, the investors don’t know whether the company will perform well enough to attract the next round of financing. If there’s a hiccup and the next round can’t be raised, it’s likely that the company will die, the next round of financing will seriously dilute the interests of current investors, or the company will turn into a zombie company that neither succeeds nor fails — nor returns cash to its investors.


Is common stock a good investment for angel investors?

Angel investors typically purchase common stock, preferred stock, or convertible notes (which are a bit of a hybrid of debt and preferred stock). The most important aspects of these investments are economic ownership in the company and control in the form of a vote, which allows an investor to protect his or her investment.

Common stock

In a typical corporation, each share of common stock has a right to one vote per director to elect the board of directors. Thus, holders of a majority of the shares of common stock control who sits on the board of directors, and thus who controls the company. In addition to voting for directors, common shareholders also have a right to vote on such things as amending the certificate of incorporation, proposed mergers, and the sale of the corporation’s business in the form of an asset sale. Again, holders of a majority (or in some cases supermajority) of common stock have the final say on whether changes in corporation’s governing documents and significant transactions can take place. (The company’s issuance of preferred stock or granting contractual rights, discussed below, can affect common stockholders’ rights.)

Shareholders also have access rights to certain company information such as stockholder records and other corporate books and records.

Founders usually hold common stock, which gives investors in common stock the protection of owning the same type of stock that the founders own. However, angels usually purchase a minority interest in the corporations they invest in, which means that even though they hold voting stock they can’t vote anyone onto the board of directors, and they usually can’t block mergers, asset sales, or changes to the certificate of incorporation. Thus, once they’ve invested their money, common stock investors won’t have much, if any, say in the success or failure of the company. However, as discussed below, holders of common stock can negotiate such protections through contractual rights.

The other major aspect of common stock is economic: all shares of common stock typically participate equally in any dividends that are paid and in liquidation proceeds after creditors and preferred shareholders have been paid upon liquidation of the company.

Preferred stock

Preferred stock has certain protective features that common stock doesn’t have. Here are some typical features:

  • Liquidation preference. If the corporation liquidates, the preferred shareholders are in line before the common stockholders, but after the corporation’s creditors. A liquidation preference is downside protection in case things don’t go well.
  • Conversion option. Holders of preferred shares typically have the right to convert their shares to common stock under certain circumstances. This allows them to enjoy the upside if things go well.
  • Antidilution protection. Preferred shares typically have antidilution protection which kicks in when the corporation issues shares below the price that the purchaser of preferred stock paid. This is protection against dilution of the preferred shareholder’s ownership interest in a later round of financing or other issuance of stock. Again, this is downside protection.
  • Blocking rights. Preferred shares often have rights to block major activities, such as selling the company, raising additional money, and increasing the number of stock options available to the company’s management.
  • Other rights. Investors in preferred stock sometimes receive rights to have a person on the board of directors, rights to more detailed information about the company on an on-going basis, and a right to participate in future rounds to protect their ownership percentage.

It’s important to note that, although the protections that are typical of preferred stock aren’t built into shares of common stock, common-stock investors can obtain some of the protections via a voting agreement or other contractual document. Angel investors should also understand that startups are wary of giving blocking rights and board seats to inexperienced angel investors.

When things go well, each round of financing fuels company growth such that the company is worth more each time it sells equity to new investors. Thus, although the early investors’ percentage ownership in the company decreases over time, the investors have a smaller slice of a larger pie and the value of their investment grows. In this scenario, many of the protections of preferred stock often aren’t necessary.

When things go poorly, however, preferred stock protections can be valuable. Antidilution features protect against dilution if the startup has to price a round of financing relatively low due to company struggles or a downturn in the economy. Joe Wallin’s Startup Law Blog post How Dilution Works is a good introduction to how dilution works. Liquidation preferences make it more likely that investors will get some of their money back if the company fails completely or has to be sold at a loss, since holders of preferred stock are ahead of holders of common stock when a company liquidates.

Convertible note

A convertible note is a promissory note that can be converted into common or preferred stock at the option of the noteholder or upon certain triggering events, such as a later financing round or meeting of developmental milestones. There are a number of potential features of convertible notes. The various features and their pros and cons are discussed in detail in this three-part article about convertible notes.

A note about authorized and issued shares

A corporation’s certificate of incorporation provides how many authorized shares — both common and preferred — the corporation can issue. A corporation can issue shares up to the number authorized. Issuance of additional shares requires an amendment to the certificate of incorporation. Thus, if a corporation has 10 million authorized shares of common stock and 1 million authorized shares of preferred stock, it can issue 10 million shares of common and 1 million shares of preferred before having to amend the certificate of incorporation to increase the number of authorized shares. If when you invest, 1 million shares of common stock have already been issued, that leaves another 9 million shares available for issuance to you, later investors, and management via stock options.

The specific features of preferred shares are generally not initially contained in the certificate of incorporation. Those features are set forth in a certificate of designations, which becomes part of the certificate of incorporation by amending the certificate when shares of a series of preferred stock are first sold.


Which type of security should an angel investor invest in?

There’s no set answer to which type of security is best for angel investors. Each situation is different, so the type of security that is appropriate in one situation might be different than the type that is appropriate in another. However, here are some things to consider:

Negotiating leverage is important

As in most transactions, the relative negotiating leverage between the investor and the startup is important. If the startup has several financing options and plenty of runway before it needs the capital, the startup will be less likely to agree to additional investor protections. The converse is true, also.

Later investors tend to receive more protection

As the company matures, the valuation tends to increase, the amount of money raised in each successive round of financing tends to increase, and the sophistication of the investors tends to increase. Thus, investor-protective features are more common in later rounds of financing than in earlier rounds. Formal angel groups, super angels, and venture capitalists all tend to invest in preferred stock, and the preferred stock issued in later rounds tends to have more investor protections than early-round preferred stock.

Early rounds set the floor for later rounds

Whatever concessions a startup gives to investors in a round of financing will be the starting point for negotiations with later investors.

Complexity costs money in legal and advisor fees

The simpler the investment, the more quickly it can be concluded and the lower the professional fees. Although it’s important to push for appropriate protections in light of such factors as how early in the process you’re investing, how much money you’re investing, and the relative valuation you’re being given, the transaction costs of purchasing preferred stock (for both the investor and the startup) tend to be higher than the transaction costs of purchasing common stock. And the transaction costs of purchasing preferred stock with a lot of investor protections tend to be higher than the transaction costs of purchasing simpler preferred stock.


Due diligence

Almost every investor will perform due diligence on the company he or she is investing in before closing the investment. The extent of due diligence that is appropriate depends on a number of factors, but the single over-arching consideration is that the due diligence you conduct must be sufficient to give you reasonable comfort to invest in the company given the nature of the business opportunity, the amount of money you’re investing, and how important that money is to you. That said, here are a few considerations:

The earlier the stage of the investment, the less due diligence there will be. This is partly due to the fact that early-stage companies don’t have much operating history or complexity, as well as the fact that you’re probably investing more in the idea and the management team than in past performance.
Negotiating leverage is important. If the startup has a number of potential investors eager to invest, it’ll be less willing to undergo a protracted due diligence ordeal. On the other hand, if it desperately needs your money, it’ll be more willing to let you look under the hood.
The more committed you are to making the investment, the more receptive the startup will be to providing information to you. Startup founders tend to be wary of giving tire kickers access to the inner workings of the company.
Some of the areas to investigate in the due diligence process include:

  • The company’s corporate documents (articles, bylaws, list of shareholders);
  • Capitalization table;
  • Authorized and outstanding securities;
  • Business plan and presentation slides;
  • Market and customer attributes;
  • Analysis of the competition;
  • Financial projections and financial statements;
  • Tax returns;
  • Cash on hand and monthly burn rate;
  • Intellectual property and protection (e.g., patents and trademarks);
  • Material contracts;
  • Use of the proceeds of the offering;
  • Reference and background checks of the members of the management team; and
  • Information about employees and employee benefits.

written by Brian Rogers of theContractsGuy. see more.


Women on Top in Tech – Dr. Sanna Gaspard, Founder and CEO of Rubitection



(Women on Top in Tech is a series about Women Founders, CEOs, and Leaders in technology. It aims to amplify and bring to the fore diversity in leadership in technology.)

Dr. Sanna Gaspard is the Founder and CEO of Rubitection, a medical device start-up developing a diagnostic tool for early stage pressure detection, assessment, and management. She is an Entrepreneur, inventor, and biomedical engineer with a passion for innovation, entrepreneurship, healthcare and medical devices. She has received recognition and awards including being selected as a finalist for the Cartier Women’s Initiative Awards(’13), a semi-finalist for the Big C competition (’14), a finalist for the Mass Challenge Business accelerator in Boston, and taking 1st place at the 3 Rivers Investment Venture Fair’s Technology showcase (‘11). Her vision is to make the Rubitect Assessment System the global standard solution for early bedsore detection and management.

What makes you do what you do? 
I am driven to have impact and improve healthcare as I have a strong drive to problem solve, comes up with new ideas, and see them come to life.

How did you rise in the industry you are in? 
I first focused on getting the educational background and then I pursued the goals I have for myself. I got my PhD in Biomedical Engineering with a specialization in medical device development. Having the educational background is important as a woman and minority to assist people in taking your seriously.  After completing my PhD, I focused on bringing my invention for a medical device for early bedsore detection and prevention called the Rubitect Assessment System to market to help save lives and improve care.

Why did you take on this role/start this startup especially since this is perhaps a stretch or challenge for you (or viewed as one since you are not the usual leadership demographics)?
I started my startup, Rubitection , because I felt it was the best way to bring the technology to market. I knew that if I did not try to commercialize the technology, it would not make it to the doctors and nurses. I also have confidence that I could manage developing the technology since I had taken classes on entrepreneurship and had my PhD in biomedical engineering with a specialization in medical devices.

Do you have a mentor that you look up to in your industries or did you look for one or how did that work? How did you make a match if you did, and how did you end up being mentored by him/her?
No, I don’t have a specific mentor in my field. I am looking for one at the moment. However, I do look up to Steve Jobs and Oprah as examples of how one can start with nothing and work their way up and build a successful, global, and reputable business and brand.

Now as a leader how do you spot, develop, keep, grow and support your talent?  
I first try to find people who have fundamental technical or work experience to be competent to complete the work. I then evaluate the person for intangible skills like independent thinking, reliability, leadership, resilience, organizational skills, strong work ethic, open mindedness/flexibility, and good communication skills.

Do you consciously or unconsciously support diversity and why? 
I consciously make an effort as a minority woman in tech, I intimately understand the need to promote diversity within my business and outside my business. I first hire the best people for the job and also make a point to hire women and minorities qualified for the position.

What is your take on what it takes to be a great leader in your industry and as a general rule of thumb?  
It takes resilience, vision, being a team player, an ability to inspire others and delegate work, knowing your weakness, and knowing when to put your business or yourself first.

Advice for others?
My advice to others is to take calculated risks, pursue every opportunity, surround yourself with supporters, build your team with smart dedicated people, and stay focused on your vision. I am striving to implement this advice myself as I work towards commercializing my technology for early bedsore detection, grow my team, and recruit clinical partners to address an $11 billion US healthcare problem which affects millions around the world.

If anyone is interested in learning more about our work or company, please contact us at [email protected].

To learn more about Dr. Sanna Gaspard, CEO of Rubitection visit:

If you’d like to get in touch with Dr. Sanna Gaspard, please feel free to reach out to her on LinkedIn:

To learn more about Rubitection, please click here.

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Women on Top in Tech – Suzanne Wisse-Huiskes, Founder of MatchBox Consultancy and an Advocate at the Global Tech Advocates Network



(Women on Top in Tech is a series about Women Founders, CEOs, and Leaders in technology. It aims to amplify and bring to the fore diversity in leadership in technology.)

Suzanne Wisse-Huiskes is a Strategic Consultant and Founder at MatchBox Consultancy with offices in the United Kingdom and Nigeria. MatchBox provides expert advise in Impact Investing, Alternative Finance, Venture Capital, Fundraising, Women Leadership, Business Development, and Economic Empowerment. She is also an Advocate at the Global Tech Advocates Network. Dedicated to challenging talented entrepreneurs, Suzanne is an official mentor at startup/accelerator programs in Africa, Europe, and Asia. She was awarded top 400 most successful women in the Netherlands for two years in a row.

What makes you do what you do?
My drive is to enable entrepreneurs to grow their businesses by improving their access to funding. This can elevate an entire community. I believe that Alternative Finance can potentially be a powerful catalyst for shifting the way our financial markets work.

I love the ingredients of the alternative finance market: the innovative nature of the industry; the global playing field; the turbo speed of change. The market is booming and shows little sign of slowing down.

I founded MatchBox to support highly motivated entrepreneurs and investors in their mission to create profitable businesses with impact. MatchBox has become a trusted partner to these clients: they value our strategic and operational expertise, as well as our strong global network used to consult and connect. The requests vary from developing large investing programs to ensure access to capital for SME’s, to developing funding strategies for entrepreneurs. What works in one country may not work in others. We understand the local players and the local markets. This work is fully aligned with what is important to me.

How did you rise in the industry you are in?
I’ve been in the crowdfunding industry since 2008. Back then, Facebook only had a 100 million active users as opposed to the 2.000 million users today. Kickstarter, one of the world’s largest funding platforms, was yet to launch. Joining the industry that early in the game, allowed me to rise with it. I was fortunate to be part of initiatives that pushed the Alternative Finance ecosystem, first in Amsterdam, then on a broader European level.

Then later on other emerging markets began to interest me. I moved to Nigeria, to work in Africa’s fastest growing economy and home to exciting trends in capital and fintech. I familiarized myself with the investing ecosystems in African countries. Today, I work in alternative finance ecosystems in Asia, Africa and Europe. Being able to learn, share and compare best practices from different economies to me is key in the rise of the industry. Currently, the crowdfunding market in Asia alone is worth over 200 billion Euros. That’s huge!

Why did you take on this role/start this startup especially since this is perhaps a stretch or challenge for you (or viewed as one since you are not the usual leadership demographics)?
I’ve always followed my heart in my professional life. I focus on work that I am passionate about and am not afraid to take the path less travelled. So leadership, demographics never held me back. With my experience and skills I am well positioned to successfully get the job done. For me it doesn’t feel like it’s a stretch.

Even more so, my clients see it as a big advantage to have women on the job. I recently worked on an impact investing program in West Africa focussing on women-led SME’s and experienced the benefits of a diverse team. Women entrepreneurs see the world through a different lens and, in turn, do things differently.

Do you have a mentor that you look up to in your industries or did you look for one or how did that work? How did you make a match if you did, and how did you end up being mentored by him/her?
The industry was completely new when I started, with no seniors to learn from. As a strong believer in mentorship, I do reach out to people in other industries for feedback and to bounce ideas.

I also learn a lot from working with various entrepreneurs. Collaborating with Sir Richard Branson in the beginning of my career was encouraging. We did a successful Crowdfunding Campaign for the elephants in Botswana. But I’m equally impressed by entrepreneurs that make a huge impact on their community no matter the circumstances. I’ve seen exceptional people grow businesses in the poorest regions of Nigeria. One can only admire their leadership.

Now as a leader how do you spot, develop, keep, grow and support your talent?
For me, mentoring young entrepreneurs is a great way to develop and grow talent. My focus is usually on two mentees at a time to ensure there is enough time to discuss ideas and challenges. I worked at fintech startups for almost 10 years before founding MatchBox. So there are plenty of stories to share and learn from, both on failures as well as on successes.

Do you consciously or unconsciously support diversity and why?
I’m very vocal on the need for diversity. I’ve always found myself in the male dominated groups. First at University, then in my first corporate position, and later as a Board Member. At some of my MBA Finance classes, I was the only woman in a room of 50 men. It never bothered or intimidated me. It just made me work a little harder.

Nonetheless, diversity is much needed. I strongly believe the industry is missing out on many brilliant women. That is why I dedicate a great deal of time mentoring female entrepreneurs. We discuss the tools their businesses require to grow and attract the right type of capital. Investors still have a different approach towards female founders. This year, we are launching an initiative called ‘the Republic of Female Founders’, to provide practical tools and guidelines that are specific for this group.

What is your take on what it takes to be a great leader in your industry and as a general rule of thumb?
My general rule of thumb: If you want to go fast, go alone. If you want to go far, go together. For me, it’s all about collaborative leadership. My industry is becoming increasingly complex, so sharing best practices will bring us far. That’s why I became an Advocate of the Tech Shanghai Advocates, part of the Global Tech Advocates. This group of senior leaders in the tech community is created to champion and accelerate the growth of the local technology sector.

I am also a fan of the CrowdfundingHub and Crowddialog in Europe, and Ingressive in Africa for similar reasons: Ordinary people doing extraordinary things because they believe in the positive impact of innovation in finance. My peers are all trailblazers in the alternative finance industry, I consider myself to be in great company.

Advice for others?
I strongly believe in collaboration, so building business relationships is key. I truly foster my relations. To me it doesn’t feel like work, but rather like building bonds. Seek opportunities to connect and reach out. It really pays off to have a strong network. At MatchBox, I work with a network of exceptional local experts. If you need advice and consulting on your funding strategy, impact investing program or crowdfunding strategy, we will gladly work with you. Contact us at MatchBox.

If you’d like to get in touch with Suzanne Wisse – Huiskes, please feel free to reach out to her on LinkedIn:

To learn more about MatchBox Consultancy, please click here.

To learn more about  Global Tech Advocates Network, please click here.

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