angel investing: 3 structures for cash distributions

There is no way all apps will achieve the critical mass required to exit. There are three investment outcomes: 1) failure 2) acquisition or IPO 3) SMB. In the SMB outcome, investors don't participate--their investment is lost. To avoid this binary outcome, I've encountered the following structures.

1. royalty-based financing: The investor receives a percentage of revenue--just like the sales force does.
2. investor put option: If the company reaches a level of success, the investor has the right to force a buyback (hence the term put option) a fraction of his holdings at a multiple of his original investment. The investor retains the balance to participate in future upside.
3. dividends: Employee cash compensation is capped. To pay bonuses, a dividend is declared.

From the point of view of an investor, royalties are most attractive. From the point of view of management seeking an exit, the put option is most attractive because the company's hit is constant. From the point of view of management seeking a lifestyle business, dividends are most attractive.

Angels seeking to optimize portfolio returns should abandon the traditional "swing for the fences" VC mentality in favor of structures such as the above.

Entrepreneurs seeking to build successful companies instead of "getting rich" should employ structure 3. If a lucrative exit presents itself, that's always an option.