Angel 101
1800 Words that will help you say Yes to Invest!
SPVs
All investing on Play Money is done through SPVs. In fact, most angel investing these days occurs through SPVs. SPV is short for Special Purpose Vehicle, a name that provides zero additional insight into what they are.
An SPV is like a mini-venture fund investing in a single company. This allows us to pool smaller checks into a single line on the cap table, which saves the founder in cap table management and legal expenses and cat-herding hassle every time they need shareholder approval for something.
Technically, SPVs are LLCs. When investing in a startup on Play Money, you are signing an agreement to be a limited partner in the LLC investing in that startup. All the SPVs on Play Money are filed under our top-level LLC: Clutch Capital. Clutch Capital is what shows up on the Founders cap table. The lead on the SPV (Yellow Purse Capital Partners - the investing entity run by the Play Money team) signs the actual investment document with the company on behalf of the SPV.
WHY SPVs
There are plusses and minuses to SPVs.
The biggest plus is accessing high-quality, vetted deals without being an industry insider. SPVs also allow you to write smaller checks to build a more diverse portfolio, no matter your budget.
There is a very real financial and administrative “cost” for every investor who shows up directly on the cap table, which is why most founders set higher minimum check sizes for direct investors.
The one big downside of investing through an SPV has always been that some, most nearly all are managed like black boxes. This is where Play Money is different.
We are hellbent on fixing the black box problem with SPVs.
First, provide your contact info directly to the founder so they can include you in their regular stakeholder updates.
Then, For founders who provide those updates, we are building a tool to help them access the expertise and networks of the investors in their Play Money SPV. More on that soon.
SAFE Notes & Terms
🤓 A SAFE note is a financial instrument used in startup investing that allows investors to provide capital to a startup in exchange for a promise of future equity, hence the term Simple Agreement for Future Equity. It’s been the standard in startup investing for a decade. Even VCs use them.
The main purpose of the safe is to set the terms for determining how much equity you’ll get down the road for the money you invested today. You are welcome to geek out on “why SAFEs vs just issuing equity” on your own.
There are two key terms in a SAFE: the valuation cap and the discount rate …and a there are a whole bunch of permutations on how those things can work together. The most common is a post-money valuation cap (with no discount). We’ll focus on that here.
If something shows up on Play Money with a different set of terms (a discount, a pre-money cap, or *gasp* an uncapped note), we’ll explain it in the deal memo.
Post Money Valuation Cap
The valuation cap sets the maximum valuation at which the investor's investment will convert into equity. It protects the investor from excessive dilution in subsequent financing rounds.
In simple terms, a valuation cap works by allowing the investor’s equity to be priced at the lower of the valuation cap and the Company valuation in the subsequent fundraising round. Valuation caps typically range from $3M to $20M for early-stage startups.
The great thing about this is that you know the minimum amount of the company you are buying at the time. $1M invested through a $10M post most safe will result in owning at least 10% of the company at the time of the conversion. If the company raises a priced equity round at a valuation less than $10M, you’ll own more than 10% because you get the better of the two.
Since SAFE converts to equity at a priced round, it’s fair to ask: What if the founder never raises money again? Will my SAFE note ever convert? Yes, the founder can convert SAFES to equity at the cap amount on their own. And SAFEs automatically convert to equity if the company has an exit event (acquisition, shut-down, IPO)
The next logical question is: What’s a “good” post-money valuation cap for an early-stage startup based on its team, market, and traction? It’s also a more complicated question. We’ll get to that later.
SPV Fees
SPVs cost money.
Filing fees with the State of Delaware.
“Blue Sky” filing fees to the state of every investor who joins the SPV.
Costs to send out distributions and issue tax statements often a decade in the future for exit events and shutdowns.
Cost for identifying compelling startup deals and creating the investor information.
Make a note of “Blue Sky Fees.” Because these are determined based on who invests in the SPV, it’s impossible to quote a flat-rate SPV price upfront. SPV organizers can provide a best guess, but they will always be variable until the SPV is closed.
All of these costs are split pro-rata between the SPV investors. The more money invested in the SPV, the lower the percentage of the total investment amount those costs consume. That said, fees passed on to SPV investors on Play Money (and on most SPVs, including those on Angel List) are capped at 10%.
So, if an SPV hits its maximum 10% in fees, a $1000 investment becomes $900 in the company.
And to close the loop for folks thinking forward: Yes, this could mean that there will be SPVs that don’t garner sufficient investor interest to cover all these fees (many of which are unknown at the start). In this case, there are two options. The SPV can be canceled or the SPV organizer or founder can pay the fees that aren’t covered by the 10%.
SPV Fees - A Cautionary Tale
Early in my angel career, I hesitated to pull the trigger on a pre-seed investment because the SPV came with a 10% fee. I loved the founder, the market, and the potential upside, but I got stuck in my head and didn’t invest. I think about that company at least once a month, wishing I was along for the ride. It stung even worse 18 months later when I read that Naomi Osaka invested in their Series A round.
The moral of the story?
Don’t sweat the fees. You make your money in early-stage investing out of asymmetrical returns. The winners are so big that they drown out all the noise of the losers and the fees.
Consumer credit cards charge merchants 3%-5% in fees.
A VC fund charges you 20% fees - yep, that 2% management fee is applied every year for a decade!!
If you invest directly on the cap table or via an RUV (essentially an SPV sponsored by the founder), most of these costs are still applicable, but they are paid by the founder….using the dollars you invested?!?!
Carried Interest: Or, as the cool kids say, Carry.
So, let’s say there is a liquidity event on one of your investments. The SPV gets a distribution for its share of equity ownership from that liquidity event. Shazam. Happy Day.
From that distribution, each investor in the SPV will get the amount invested in the company returned to them. Woot!
If the distribution is large enough, the remaining money is the profit. Those profits are split between the investors (you) and whoever organized the SPV. The percent of the profits that go to the SPV organizer is called Carry.
20% Carry means investors get 80% of the profits, and “folks involved in the SPV” get 20%. Sometimes, Carry will be lower than 20%; in that case, you will retain more of the profits.
Ownership, Dilution & Following On
TLDR: If you are building a diverse portfolio of early-stage tech-scalable investments (aka not writing 6-figure checks into single startups), you likely won’t be able to make follow-on investments to preserve your ownership percentage. That right and access point are usually reserved for the most significant investors or for folks *super* close to the company —and that is just as well because both math and experience show that “following on” might not be the best strategy for individual investors.
Many VCs have the strategy of “following on.” This means they invest in a subsequent round of fundraising—usually at a higher valuation—to maintain their ownership of the company and avoid dilution.
At first blush, this sounds smart. But dilution sounds bad, and owning a more significant equity position in companies that look like they might be winners sounds good. It’s not always so clear-cut, though.
HOT TAKE: Angels are not small VCs
There are very specific reasons VCs follow on - but angels are not small VCs.
Analysis of all the investments made on Angel List over the past 10+ years suggests individual angels should NEVER follow on. They even coined the term “infinite regret” to describe what can happen if you follow on instead of making a net new investment. That’s big talk!
Recent posts from Harry Stebbings looking across the industry suggest that doubling down on their Series A and Series B “winners” may be a false flag in pursuing the best financial outcomes - even for VCs!!
This is provocative stuff. We’ll talk about it more later.
In other investing categories - such as CPG - the math is different. But the reality across any type of early-stage investment is that unless you are writing a big check directly on the cap table, you likely won’t have the opportunity to “follow on.”
Taxes & Distributions
The K-1 is the tax document associated with startup investing via SPVs. Tax returns and K-1s are only required to be filed with the IRS if there is taxable income or loss to report for a given tax year.
You don’t have to worry about taxes until one of the companies you invested in has a financial event that affects shareholders. This could be a “liquidity event” such as an acquisition or IPO where they return money to investors - or a shutdown. When this happens, don’t worry, you will know.
We’ll email you when K-1s are issued. That document will be sent via email and provided directly on Play Money.
Angel investing is also a very tax-advantaged asset class. We’ll dig into that more in Setting Your Angel Budget.
Recap
It’s great to have a basic understanding of the terms you will encounter on your Angel journey. But sometimes, the most useful experience is to dig right in.
There is no shame in playing “Lurk & Learn” for a few months before you jump in with your first investment. And there is no shame on pulling the trigger on day 1.
And as you’ll quickly see, as long as you are investing in clean well-lit spaces, there is a lot of flexibility on how to develop an angel style that works for you.
