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Angels?? and Partial Exits ?

EXITS are the nirvana of angel investing. For some, it is this pecuniary reward they are battling for in the startup game, for others like myself, it is validation that all that the free time has been given to the right entrepreneurs and has not been wasted. Exits are a crucial part of the cycle of angel investing, without them, all angel investors will sooner or later run out of funds to reinvest. In that case, they would ultimately stop helping startups to get ahead. So it is important that investment funds can be recycled before compulsory retirement is forced upon angel investors due to a lack of funds. However, this is less of a problem for some of the super-angels in Silicon Valley.

Basil Peters has influenced much of the exit thinking in the world of angel investing since his book Early Exits first appeared in 2009. It is a great read and focuses on the timing of and the preparation for exits. In general, a trade sale is preferable over and IPO as it can be achieved many years earlier and therefore bears less risk.

Jeron Paul discusses in 2015 a special form of founder-friendly stock which comes "with early liquidity rights and contains a built-in right for the holder to sell shares in any future fundraising events. This allows the holder to get cash in exchange for stock often much earlier and much easier than is usually the case." However, this is for founders, not angels. Too much early liquidity for founders could weaken their motivation to work hard towards the final exit.

Florin Dorobantu looks at Syndication and Partial Exit in Venture Capital in 2006 as a signaling game. "During initial involvement with the entrepreneur, the venture capitalist becomes informed about his ability by observing the quality of the firm he invested in. He then sends a costly signal in the form of an underpriced partial exit of the venture capital fund from the portfolio firm – a syndicated financing round in which the fund reduces its share in the firm, essentially selling a fraction of the fund’s ownership share at a low price relative to its expected value. In equilibrium, only the high-ability venture capitalist is willing to undertake costly syndication, because he expects high gains from managing the follow-on fund." 

A partial exit is the divestment of part of a holding in a company, usually shares.

In my opinion, founders and angel investors are working together most effectively when they are aligned on the same exit goal, in terms of timing and size. Most fast growth companies require multiple funding rounds along their path to the final exit. Each follow-on round is critical for the overall success of the company and for the return of all the capital that was invested earlier.

Startup founders tend to work on salaries below going market rate which keeps them sharply focused on the capital gain on exit. Later investors often look for signals from earlier investors and would expect from them some measure of follow-on investment to demonstrate their confidence in the company. If the value of the company has moved upwards by a significant multiple this may no longer be expected.

Later stage investors such as VC's require minimum parcel sizes to warrant the effort involved with their investment. What when there is less than that minimum left in a funding round?

? Oversubscription is an obvious and very popular option but putting too much money into the company may unnecessarily increase the burn rate and it can accelerate founder dilution to an undesirably low level.

? The VC can invest the surplus funds into the company by purchasing shares from existing shareholders in a partial exit. There are three cases to consider.

1. Shareholders can agree to all sell pro-rata. If alignment and trust are good this should also apply for founders. The founder rate may be less to limit dilution. However, some early liquidity can be a good motivator and align hitherto cash poor founders better with investor shareholders.
2. The personal circumstances of shareholders and their liquidity needs are usually different and can be negotiated. This is easil when the company prospects are considered to be positive but more difficult otherwise when all shareholders want out. Careful, this is another signaling point to the incoming investor.
3. There is an unpleasant variant of the partial exit. In some circumstances, an existing shareholder can in accordance with the shareholders' agreement block new funding and thereby blackmail the incoming investor to purchase some (but usually all) of existing shareholder's holding.