The Legal Terms That Matter Most to Angel Investors
When it comes to early-stage investing, much attention is placed on financial projections, founder charisma and product potential. However, the legal architecture of a deal can either support or undermine long-term outcomes. While we believe that legal terms are not the primary driver of business success, they are a critical foundation for building trust, managing risk, and enabling growth.
Christopher Mirabile - angel investor, co-founder of Seraf Investor, and former Chair of the SEC Investor Advisory Committee - delivered a candid assessment of the legal terms that actually matter in early-stage investing. His insights, originally shared on the podcast with our good friend Gary Ross, 'The Legal Terms That Matter Most to Angel Investors', are rooted in US experience, but resonate widely.
This article unpacks 10 of his core observations and compares their relevance to New Zealand's venture landscape.
1. Convertible Notes and SAFEs: Elegant but Misaligned?
US Viewpoint: Mirabile dislikes the proliferation of convertible notes and SAFEs. Originally intended as short-term bridge instruments, they’ve evolved into mainstream financing mechanisms. He argues that they are fundamentally flawed, citing misaligned incentives, poor investor protections, a tendency to deliver “equity risk for debt returns”, and despite the call for “simplicity”, are actually complex, as almost all SAFE terms are negotiated between rounds and different companies.
NZ Context (Very relevant): While convertible notes are more common than SAFEs in New Zealand, SAFEs are also prominent, often imported from the US-based accelerators. Their lack of investor rights (e.g., no maturity date, no interest, limited enforcement options) can pose significant investor risks. Although SAFEs offer simplicity and speed, these advantages can quickly turn into liabilities without adequate individualisation and investor safeguards.
2. Common vs Preferred Equity: Aligning Outcomes
US Viewpoint: Mirabile suggests that when priced rounds are viable, investors should opt for equity rather than convertible instruments – and either common or preferred. While common stock offers strong alignment with founders, it offers limited downside protection. Preferred stock, by contrast, provides additional rights, such as liquidation preference and anti-dilution protections that monetarily reward investors for taking a monetary risk on the venture.
NZ Context (Relevant): New Zealand investors often receive ordinary or preference shares, based on the stage of the company. At seed or Series A stage and later, the use of preference classed shares with embedded liquidation, anti-dilution and, in rare cases, distribution rights is not uncommon.
3. Pro Rata Rights: Critical for Upside
US Viewpoint: Pro rata rights - giving investors the ability to maintain their ownership stake in future rounds - are considered the single most important term. They enable investors to double down on successful companies, which is crucial in a portfolio where a small number of winners generate the majority of returns.
NZ Context (Very relevant): New Zealand’s Companies Act provides pre-emptive rights by default, but these can be excluded by a company’s constitution or shareholders’ agreement. Angels must ensure pro rata rights are explicitly preserved in the relevant documents (and check what the exclusions are, such as issues under the company’s ESOPs).
4. Liquidation Preferences: Market Norms vs Red Flags
US Viewpoint: A 1x non-participating liquidation preference is considered standard. More generous terms to investors - such as a 1.5x, 2x preference or participating rights - potentially raise red flags, either signalling issues with the deal quality or potential friction with future investors.
NZ Context (Relevant): Liquidation preferences are more or less standardised in New Zealand, using a 1x non-participating structure. For non-standard liquidation rights, please see the “Bozo Insurance” below.
5. Anti-Dilution Protections: Best if Boring
US Viewpoint: Broad-based weighted average anti-dilution protection is the gold standard, balancing fairness and practicality. In contrast, full-ratchet terms are seen as aggressive and can undermine long-term alignment.
NZ Context (Very relevant): Anti-dilution protections are increasingly seen in Seed or Series A and later rounds. Broad-based weighted average clauses are market, particularly when institutional investors are involved.
6. Participating Preferred with Sunset Clauses (“Bozo Insurance”)
US Viewpoint: Some investors, like Mirabile’s Launchpad Venture Group, negotiate using “bozo insurance” in the form of participating preferred terms that revert to non-participating if the company performs reasonably well. This non-standard structure offers downside protection in poor investment or exit scenarios while avoiding ‘poisoning’ future rounds. The bozo insurance would be most useful when there is a large gap in valuation expectations between the founders and the investors.
NZ Context (Interesting, creative): This approach is not the standard in New Zealand. Similar temporal downside protections are sometimes negotiated and may appeal to sophisticated angels or syndicates. The challenge lies in striking the right balance between early investors’ risk protection and maintaining friendliness to founders and follow-on investors.
7. Information and Reporting Rights: Build Trust, Not Silos
US Viewpoint: Mirabile cautions against using “major investor thresholds” for receiving company updates, arguing that all angels deserve some visibility. He recommends minimum quarterly reporting structured around five core questions:
o What did we learn?
o What went well?
o What didn’t?
o What are the challenges?
o What do we need help with?
NZ Context (Relevant, important): While basic shareholder inspection rights exist in the Companies Act, good investor communication is often ad hoc. Implementing structured, proactive updates strengthens alignment, enhances accountability, and encourages deeper engagement from investor networks. We often see proactively communicative companies moving much faster and with more widespread support when raising capital or needing to obtain any shareholder approvals.
8. Founder Vesting: Protection for All Parties
US Viewpoint: Founder vesting isn’t about mistrust; it’s about protecting the team from each other. When explained properly, most founders support vesting, especially in newly formed teams. Customisation is key (e.g. partial vesting credit for time already served) with a focus on being fair and reasonable.
NZ Context (Very relevant): Some founders view vesting as punitive. But when framed around the logic of ‘team continuity’ and ‘de-risking’, the rationale can gain acceptance. Most shareholder disputes are between the founders, and a logical, fair vesting schedule would avoid most of those disputes.
9. Governance and Control: Avoid Overreach
US Viewpoint: Overly restrictive governance rights (e.g. veto over leases, hiring, or day-to-day decisions) can demoralise founders and strain board dynamics. Governance should focus on genuinely material shareholder and equity matters, not operational micromanagement. Monetary thresholds to trigger board or investor consent should be proportional and change with time.
NZ Context (Relevant): Investor reserved matters are common but are often approved by an investor-appointed director, rather than the investors directly. This has some benefit to the company because directors have to act in the best interests of the company (not just their appointing shareholder). Nevertheless, relationships can strain when investors demand too much operational control (for example, with disproportionately low monetary thresholds requiring investor consent) without understanding its chilling effects.
10. Efficient Closings: Don’t Drop the Baton
US Viewpoint: The importance of smooth deal execution and closing is often overlooked. There is a clear value in practical tools such as:
o Omnibus signature pages.
o Clear, secure instruction sheets including payment instructions.
o Defined communication protocols.
These help ensure momentum is maintained through to closing.
NZ Context (Relevant): New Zealand deals, particularly those involving multiple angels, can suffer from loose coordination and delays. They can also result in technical breaches of investment documentation by the company (or the investors). Often, these are advisor-specific issues, with some thinking very clearly about investor experience on closing and others not so much. Appointing a lead investor and engaging a lawyer experienced in startup transactions can streamline things and avoid last-minute complications.
Final Thoughts: Legal Terms Are Not the Main Event
What matters most are the team and opportunity, not legal minutiae. But getting the legal structure right helps unlock value, avoid disputes, and lay the groundwork for growth. In New Zealand, as our startup and angel ecosystems continue to mature, there's a real opportunity to adopt global best practices while staying lean, relationship-driven, and pragmatic.
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Disclaimer
This publication should not be construed as legal advice. It is necessarily brief and general in nature. Please seek professional advice before taking any action in relation to the matters discussed in this publication.
