Return on Investment

For a Lower Investment Return – Agree to a Covetable Note or SAFE Structure.


To say I am not a fan of Convertible Notes or SAFE as a form of investment would be somewhat of an understatement. The big reasons I see for Convertible Notes being so damaging is that Angels using Notes rarely get their agreed terms of conversion.

One of the most common cram downs on Angels with Notes is the class of shares they end up with (as opposed to, were promised). The Angels enter a note with a 20% discount (what experienced Angel thinks 20% valuation growth in 6-12 months is anywhere close to adequate?) and a promise that their Note will convert into the same class of shares as issued at the next round. The VC round (or pretty much any other investor) at the next round says “No way!”, they can’t have my preference shares, let them convert into ordinary, or at best, a preference behind the new investor. So now the ridiculously low discount rate, the probably over generous (high) cap and the failure to achieve preferential terms means the Angels with Notes are not even getting basic dilution protection on the round.

Of course, the Angels would not normally agree to such abuse but, as a Noteholder they are not at the negotiating table for the new round (the Note does not give them the full investor protections typical in a priced round). Ultimately, they are presented with a ‘take it and get f*$ked’ deal. It is not uncommon for other terms of the Note to be abrogated too.

Fortunately, I live, and largely invest only in a geography (the UK) where Convertible notes and SAFE are effectively unknown (and given that the UK is the largest Angel market in Europe, that in itself points to the fact that neither are necessary to ensure companies get funding!).

The use of both Convertible Notes and SAFE has emerged from the USA, and initially largely the West Coast. In practice SAFE’s are not used nearly as frequently as they are talked about by early stage entrepreneurs. They are a minor part of early-stage investing, account for just 4.7% of seed deals in the USA[1]. SAFE’s account for about 10% of seed deals in California – influenced by Californian Incubators. Elsewhere investors are less enthusiastic. A recent post by Launchpad Venture Group described them as “a cancer of the investing world[2].

Convertible Notes are more common, accounting for up to 50% of seed deals in the USA[3] (for series A deals, just 12% were Convertibles). So definitely used – but as many commentors suggest, not necessarily the preferred choice of many investors. See  for 10 reasons not to use Convertible Notes.

And now for reason 11 – if you use Convertible Notes your investment returns will suffer. Launchpad Venture Group looked at 484 individual investment rounds that the group has made using Total Value to Paid-in-Capital (TVPI) return multiples. This metric measures the current value of the investment (both realized and unrealized) as a multiple of the cash invested.  They found that their returns were significantly lower when investing in Convertible Notes (1.1x) and SAFEs (1x) in comparison to Equity (2.2x)[4].

The Launchpad TVPI multiple on convertible notes and SAFEs is half what it is for preferred equity, and this difference is sustained over 258 rounds of equity investment and 188 rounds of investments in convertible notes. 

Digging Deeper – Why are Convertible producing such a poor relative return?

  1. Positive Exit – For 5% of note rounds, this was the last round of financing and the company successfully exited without needing to raise additional funding. This is a best-case scenario where notes were used as a bridge to an exit, and the investors received a 1.55x return on their investment. A positive return, but lower than the average equity returns of 2.2x because noteholders only receive the benefit of their discount or cap at the time of exit rather than benefiting from any growth of equity value.
  2. Note Converted to Equity – 35% of Convertible Notes behaved the way they are supposed to and converted into equity at the next fundraising round. The average returns of 1.3x in this outcome reflect the note discount or cap, but are below average equity returns. This highlights the likelihood that the majority of discounts are set too low (25% is just not enough), or the caps too high (eye off the ball, allowing too high valuations).
  3. Not Yet Raised Another Round – 11% of the rounds were recent enough that the company hasn’t yet raised another round of financing, but the company is still active. These notes are being carried at their original face value of 1x investment.
  4. Company Failed – 4% of the note rounds were the last investment before a company failed, and they returned nothing.
  5. Raised Another Note Round – This may be the area of significant issue for Angel investors – 44% of note rounds were subsequently followed by yet another note round. Serial-note rounds kill investor returns by delaying a conversion to equity and hence delaying the point at which the investors benefit from real company value growth. Investors are effectively receiving debt-level returns for equity-level risk taking. Many companies that raise capital through a succession of note rounds (often motivated by fear of dilution – possibly driven by lack of value creation?) remain under-funded and continue to struggle to hit real value inflection points. In many cases investor controls within the Note are limited to non-existent, so the investors have no say in how many notes are issued in the future.  For such companies, the Launchpad returns were just 0.84x.

It’s hard to achieve positive returns as an Angel Investor. Do you really need the added drag of a Convertible Note or SAFE structure?

[1]The 2019 HALO report found that SAFEs were most frequently used in Mid-Atlantic Region at 12%, likely heavily influenced by US Federal DOE, NSF, NIH, and other grant money which does not permit debt as a liability while grant funds are in use, hence early stage companies who do not wish to price their round are opting for SAFE notes.

[2] ACA Data Insights, 22 July 2021.

[3] 2019 HALO report

[4] To get a clear picture of round-level returns, they linked back the ultimate playout from a company to the actual round where capital was invested. For example, if invested in a convertible note round that later converted into equity as part of a subsequent fundraising, and then paid a return over two separate milestone escrow payments, they needed to determine what portion of each escrow payment came from shares converted in from the note into equity in order to determine that note’s ultimate return.

For Increased Returns – Plan Future Rounds and be Capital Efficient.


Having seen many Angel investors be washed out by dilution and the preferences held by later investors into a company, particularly VC’s, I have adopted a stratey of looking for capital efficient investments (that won’t need VC to exit).

These tend to be B2B business with some real IP. Its necessary to develop some sales – to quality customers, but not necessary to scale the business to show value.  Acquirers need to see that “the dogs will eat the dogfood”, but you don’t need to feed every dog to do this. Just the big dogs that acquirers are likely to care about. Then sell the business, not on the PE multiples of the investment business, but on the acquirers PE – the value of the futures sales and profits they will make pushing the product through there much larger distribution channels.

Yes, product sales need to be scalable – but that scaling does not need to be done by us to prove value.

Typically, we are looking at total lifetime investment values of up to $5m – so a 10X return on a $50m exit. Which just happens to be the average published exit value.

Till now this has been intuitive – a belief that this is an effective strategy.

The American angel Capital Association (ACA) have just published some data looking at the returns achieved on 105 investments within the Launchpad Venture Group portfolio.

Turns out that those investments that were done on a capital efficiency basis – Thinking about future capital requirements and giving preference to capital efficiency (where the diligence team did not think it would need to raise more than $5M in outside capital over the course of the business) increased returns by 35%.

Capital efficiency and future planning – less capital at risk, spreading your investments over more (smaller capital need) deals, less dilution and likely earlier exits, with a 35% better return. What’s not to like?

Are Angels in Denial About Exit Valuation?


There are three variable that drive the financial return for Angel investors (and founders):

  • Pre-Money Valuation.
  • Subsequent Dilution.
  • Exit Amount.

Instinctively founders seek as high a valuation as possible. It must be a ‘good thing’ to ‘give away’ as little equity as possible. Typically, founders will seek to find comparatives to justify their valuation proposals. If company X is worth $6m then we must be too.  (Let’s put aside for the moment that the comparative being used is likely on a different continent, and probably has quite a different set of skills in its team, different experience in its founders, and different intellectual property).

And it seems many investors have been going along with this. Perhaps out of fear of losing out on ‘the best’ deals – though I have yet to meet anyone who can actually pick winners at the first round (or follow on actually) – if angels could do that then presumably the percentage of their portfolios that fail to return capital would be less than 70%.

A big part sems to be a failure to think strategically about a deal – looking not just at a first-round valuation, but at the total cash that business is going to need to get to an exit (and the resulting dilution on their ownership %), and the actual likely exit value achievable.

And this in turn is likely significantly due to the media fixation of Unicorns. Without appreciating that it’s the valuation of most unicorns that is a fantasy. Because so much talk is about $1bn companies that’s become the perceived normal – the bar against which all else is measured – and found wanting.  But over the last 10 years just 1.7% of all UK high growth company exits have achieved a value of $1bn or more.

The unicorn culture has stopped people talking about, and admitting to, the reality – most exits are much, much smaller. And no, its not because we lack ambition in the UK – the exit values in the USA are largely at the same level. As with most commercial transactions the buyers have a price band they are comfortable paying. Trying to ‘scale’ past this comfort zone (which is a reflection of the acquirer’s commercial reality) is more likely to create a non-exitable company – and certainly massively dilute the early investors, and probably the founders as well – than crate added exit value.

Triple Point and Beauhurst have produced a report looking at 2,724 exited UK companies between 2011 and 2019[1]. Of these they have exit value data on 604. It’s likely the bulk of the non-disclosed deal values will be at smaller values. Big deals are publicly announced (either publicly or in financial accounts). Small deal value announcements are likely inhibited by embarrassment under the prevailing unicorn culture.

The data shows that 87% of exit values are under £200m. But digging deeper, 51% are at £30m or less.

Most Exits are ‘Small’.

This is not a reflection of lack of ambition by UK founders – or a lack of UK scale up capital. The 2016 ‘Global Tech Exit Valuations’ report by CB Insights showed 54% of exits globally were at $50m or less (and they also pointed to the fact that the majority of smaller exit values are not made public, so that figure will likely be significantly overstated). Rob Witbank’s study presented to the American Angel Capital Association conference (ACA) suggested that 87% of US exit values were $50m or less (perhaps significantly impacted by the high level of ‘acquihire’ transactions, where a large tech company purchaser a small tech company just to get the technical team – the acquired company being quickly shut down. The technical skills of the team being seen as more valuable to the likes of Google than the  product they were working on).

Exit value is critical in determining the financial return on all investments made into a company, including the very first. It’s hard to see how you can get the target 10x return from a deal (the generally agreed target needed to archive a 2 – 3x return at portfolio level given the very high, 70%, level of deals that will produce a negative return) if the first round valuation is north of £3 million, and the probable exit vale will be sub £50 million (even without considering any future funding dilution, or preferential returns introduced by subsequent funders).

The report shows that 97% of exits have been via an acquisition (as opposed to an IPO), and the average acquisition exit value has remained unchanged over the past ten years. Yet data from Pitch Book shows entry valuations have been significantly increasing in the UK, with Angel and seed valuations rising from about £1 million in 2010 to £3 million in 2019.

Mean Acquisition Exit Values Flat over 10 years.

There is no rational reason to accept an increase in entry valuations of 3x while exit values have remained flat. Perhaps it supply and demand – all that SEIS / EIS incentivised (dumb money) investment chasing quick deals to beat the tax deadlines. Perhaps it’s that before COVID chased them away Angel tourists thought it was cool to get into some ‘hot’ deals. Perhaps we investors have just not been looking for, and using, the realities of the data to negotiates sensible valuations, and been willing to walk away from the daft ones.

How do you calculate the ‘correct’ valuation? Comparatives have some merit, providing you are using a genuine comparative. Don’t go comparing your e commerce, shoe comparison site with a San Diego Biotech company.  The Score Card method can help focus on the key issues to be used in due diligence, but if the management team is not excellent, you don’t compensate by lowering the valuation. You just don’t do the deal.

Truth is, startups have no value. How can they, if 70% end up failing to return capital (and obviously we don’t know which are in the 70%!). The 70% are probably worth less than zero at initial funding – because your going to lose money on them.

So how does valuation actually work? The early investors need to take 20-30% ownership to manage future dilution and have a decent ownership at exit, to derive that 10x potential return. This assumes a reasonable level of investment is going in, depending on location, say $100,000+. The valuation is derived based on that percentage, and the amount of funding the company needs to achieve credible, critical value add mile stones. If the company needs £500,000, and the investors take 25%, the post money valuation is £200,0000, and the pre £1,500.000. If the company needs £700,000, that valuation is £2.8m.

(The founders get the balance of ownership, less the 15% or so that is popped into the share option pool. Always get that set up at the time of your first investment – otherwise it will add further dilution when the next investor require it).

Is that £2 million valuation sensible? Depends on how much more cash needs to go in to get to exit, and the resulting dilution on the investors. That needs to be modelled on a future looking cap table, showing each expected future round, amount, valuation and dilution effect.

And then look to see what is the probability of achieving an exit big enough to get a 10x return. In simplistic terms, a £2 million entry with no further funding or dilution needs a £20 million exit. The data we have above suggest that 62% of exits are at values above £20m. Reasonable odds, as long as there is no more dilution. But it’s a rare company indeed that gets to exit, especially above £20 million, on a single round of funding.

This suggest that you would likely not want to be going above a £2 million valuation. And yet clearly the data indicates that investors regularly are. Perhaps all the higher valuations are for companies that are just that much more ‘special’.

Valuation is important, and does need to be considered in conjunction with future capital needs, dilution and the realities of exit value. Exit values of genuine comparatives, of similar companies in the same geography. And investing on the same terms. A valuation of £3 million is a very different value when the investor has a 3x preferential return built in.


What is Capital Risk for Angel Investors?


Few Investors (or founders) look beyond the immediate funding round in any detail (if at all). Yet Assessing Capital Risk is critically important when assessing if this is a deal you should do – even if every other indicator is screaming “Yes”.

Every deal I have ever seen has needed more than one round of funding to reach a successful exit. Most need multiple rounds of funding – perhaps 5 to 8 is typical, over 5 to 10 years.

If that follow on funding is not going to be available, or you don’t build something the next round funder will invest in, you are not building a bridge to a profitable exit, you are building a pier to nowhere.

So, asses what is the Capital Model for this deal going forward, and get answers to the fooling questions:

  • How much additional cash will company need?
  • Where will that cash come from?
  • On what terms can we get it?
  • What will Funding environment be like in 18 months?
  • Will we need a VC partner?
  • What terms will the VC offer?
  • What does this company have to have / look like (users, customers, data etc.) to be of interest to those VC’s? Can we achieve any of that on the funds we are about to invest? Is the target of the business plan to achieve those key requirements?
  • Will they need so much capital that follow-on VCs will wipe us out? (Dilution + Preferential Returns).
  • How big an exit will we need to hit Our Target Return – if this company is successful, can it get close to that number?

Risk – Embrace it – It’s where the Profits Are.


Risk is impossible to avoid in any business. For Angel investors looking at the first rounds of funding going into a start-up the risks are particularly significant.

Angel investors make decisions to invest under conditions of extreme uncertainty. Angel investors face cases in which uncertainty is so extreme that it qualifies as unknowable. They decide on investments in ideas for markets that often do not yet exist, and they propose new products and services without knowing whether they will work.

For experienced Angel investors rather than being undesirable, unknowable risks are deliberately sought. It is by investing in companies with unknowable risks that they can find the most attractive, most profitable investments.

Experienced Angels do not seek to maximize each decision but instead seek potentially extraordinarily profitable opportunities and accept what may seem like a high failure rate. They rely on building a large portfolio to spread risk and accept that the overall failure rate, by number of investments, may be as high as 70%, even in the most developed capital markets[1]. Typically 85% of all returns come from just 10% of investments made. They are willing to accept that most of their investments will be total losses.

It is critical to understand that for Angels a ‘fail’ is not a company in liquidation. It’s a company that fails to return the investment capital and an investment return on top. Indeed, depending upon the local tax regulation a zombie company – one that keeps going but with no likely prospect of an exit for the investors – is worse financially than the liquidated company. At least if a company is liquidated I get to offset the loss in my tax return.

Angels use Due Diligence to assess risk. A due diligence process therefore needs to cover the key risk categories –

  • Management Risk
  • Technical Risk             
  • Competitive Risk      
  • Market Risk              
  • Intellectual Property Risk
  • Regulatory Risk
  • Team Risk

Many Angels however do not spend enough time looking at the two most critical risks – that will kill a return on investment even if everything else is as close to perfect as can be –

  • Capital Risk – how much follow on cash is this company going to need – can it get it, and on what terms?
  • Exit Risk – is anyone ever likely to want to purchase this company – and at what price?

[1] 2016 Angel Returns Study, Angel Resource Institute, 2016.

Angel Investing – Not Just for the Supper Wealthy (who are usually not very good at it anyway).


The Best way to be an Angel Investor? Become a member of an established Angel Group of Network and join in lots of deals with other members, investing just a little initially in each one. Let’s say a company was looking to secure £250,000. That should be provided not by one of two really rich individuals, but by 10 or more individuals each investing between £10,000 and £40,000. Why? Because Angel investing is very risky – as many as 70% of the Angel backed companies in the USA fail to provide a return to the investor – so the reality is, however good that pitch looked, no one, however experienced they are, can pick the winners.

Angel investing can be highly profitable, with organised angels with a portfolio investing strategy achieving IRR returns of 25% (and one Angel friend showing a 101% IRR!). But you must do a lot of deals. Less than 6, and the probability is you will not get any return. You need to be planning to do 15 to 20 new investments over say a 5 year period, recognising that many will not manage to develop as planned. Then be prepared to provide follow on funding only to those that do show real development and in particular customer traction. Don’t keep funding the ones that don’t perform (and they will likely be the majority!). It’s only after the company has been actually operating for a few years that you will have any chance of starting to see which ones are likely to be the real winners.

And the only practical way to be able to invest the necessary cash, and time, across such a large number of investments is to do it as a “team sport”, investing with as many other Angels as you can, providing small amounts of initial funding each, and then building on the successes with more capital. A good rule of thumb is that for every £1 you provide as an initial investment, you need to plan on providing another £3 for follow on into the “good” ones.

Being part of a group has many other advantages.  Usually better access to deal flow as the Group will be better known than individuals, certainly more people and brain power to do screening and due diligence and access to much more post investment support.

And why are the Supper Wealthy usually not very good at it? They don’t share the deals, and put too much money into too few companies, and don’t have the time to provide adequate post investment support into a properly sized portfolio. Better to be a team player.