A new innovation: Angel investors seeking exits by getting a portion of startup’s revenue

The last week we had over 25 folks who run accelerators, incubators and coworking spaces in India at the Microsoft accelerator. A few of them were individual angel investors as well.

Anyone who has invested in Indian technology startups knows that getting exits is hard. In fact in most of our discussions with entrepreneurs nearly 60% of them have the intention to never sell their company or “exit” but to build a standalone business which generates cash and employment. Given that number, it is not hard to imagine that most angel investors are vary of investing in startups given how many of them end up as “lifestyle businesses”.

Most angel investors, though need exits and returns on their investment. This is so they can redeploy the capital and the gains in other investments.

I have seen many creative ways that angel investors have tried to get exits from their investment in India. Unlike the US, nearly 40% of Indian angel investors (according to Rehan Yar Khan of IAN) usually exit at the series A or series B stage. At this stage either the new investors or the company buys their shares out.

I heard for the first time though, about a new technique adopted by an angel investor. This investor had a preset IRR (Internal rate of return) which they agreed to with the entrepreneur and required that the entrepreneur return the investment with the gain when they start to make a certain amount of revenue.

It seems more like a debt investment than an equity investment, but it seemed to work.

I have seen many investors who put money in non technology companies who put together deals like this one, but its rare for technology companies.

I wonder, how many entrepreneurs are okay with accepting these terms as part of their investment. I suspect that if entrepreneurs get more comfortable with convertible debt to equity instruments with some form of exit criteria tied to revenues, this will become a more viable vehicle for technology startups.

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8 thoughts on “A new innovation: Angel investors seeking exits by getting a portion of startup’s revenue”

  1. Raghuram Rajan in his book Fault Lines wrote a chapter titled “When Money is the measure of all worth”. I quote from the chapter page 124 “Most Direct measure of both of a financial sector worker’s contribution is the money – the profits or returns – she makes for the firm. Money here the measure of both the work and her worth.”

    I express my strong reservation to using suggestive word “lifestyle business” for those entrepreneurs who are not willing to sell their business.
    I can similarly use the word “greedy” for the Angel investors you are talking about.

    1. Gaurav, when you take money from an investor it is your fiduciary and moral responsibility to return it. They are putting money in to get a return. If you never intend to return it, then dont take money from the investor. If as an entrepreneur you decided you do not want to grow your business, but are happy with its slow progress, then its your responsibility to give the money back to your investor. Lifestyle is when you dont want to grow your business and dont want to return money back to the investor.

      1. If an entrepreneur has taken money from an Investor, then both the parties are bound by legal contact enforceable by law.

        My point is if an entrepreneur is not interested in taking the money from Angel. It should be equally fine why call names like “lifestyle business”.

        The source of term itself is unclear and Wikipedia http://en.wikipedia.org/wiki/Lifestyle_business is looking for precise citation. I quote from Wikipedia

        Quote
        This article includes a list of references, but its sources remain unclear because it has insufficient inline citations. Please help to improve this article by introducing more precise citations. (December 2010)
        Unquote

  2. Convertible debt has, in my experience, been more unacceptable to investors rather than entrepreneurs. Convertible debt is awesome for the startup – if you succeed, you can just return the money with the IRR and keep the equity. If you fail, it’s like equity where it’s pretty much gone other than whatever assets are left. Angels have been wary of such investments in India because it doesn’t give them as much of an upside while retaining the full downside.

    However it makes more sense to do convertible debt. It also helps with unclear valuations – if you don’t know how much to value a co today, you agree on a 30% discount (pro rated) to a future round and go on with the convertible debt issue. Plus in the income tax law that intended to tax equity investments from non-VC firms, startups don’t get impacted if it’s convertible debt.

  3. I think if Investor and investment firms wants to invest in Indian startup’s successfully then IRR is better option for many of the startups. Indian’s and indian startups believe in different stories then US or western startups, Here both sides (startup & investors) are pointing at each other for a change, since both come from different set of stories and thought processes. I think valuation of a company should be based on IRR and investors exit plan too. Balance of both sides is required if we want to grows start up culture in India.

  4. It is important that the angel investors get healthy exits and recycle to fund new start-ups. However, a revenue share based return will not help potentially explosive start-ups like the ones in silicon valley that build a large consumer base before generating ad-based revenue. It is better to work on a convertible debt or an exit in Series A/B round, as is the current practice.

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