Brian Nichols is the co-founder of Angel Squad, a community where you’ll learn how to angel invest and get a chance to invest as little as $1k into Hustle Fund's top performing early-stage startups

Angel investing seems mysterious until you understand the mechanics. Strip away the complexity and it's straightforward series of steps and structures.

How startup investments actually work from first dollar to eventual exit or failure.

The Investment Vehicles

SAFEs (Most Common): Simple Agreement for Future Equity is standard early-stage investment instrument. You give company money now in exchange for right to future equity when company raises priced round. SAFE doesn't grant you shares immediately, it grants right to convert to shares later at favorable terms.

Key terms: Valuation cap (maximum valuation at which your SAFE converts), discount (percentage benefit if converting at next round, typically 10-20%), and pro-rata rights (ability to invest in future rounds to maintain ownership).

SAFE was created by Y Combinator to simplify early-stage fundraising. It's now standard instrument most startups use for pre-seed and seed rounds.

Convertible Notes (Less Common Now): Convertible notes are debt that converts to equity at next priced round. They accrue interest (typically 2-8% annually) and have maturity dates (when they must convert or be repaid). Most notes also have valuation caps and discounts similar to SAFEs.

Convertible notes have fallen out of favor because debt characteristics create complications. SAFEs are cleaner and now dominant.

Direct Equity Purchases (Rare at Earliest Stages): Some investments involve buying equity directly at agreed valuation. This is called priced round. Company establishes official valuation, issues shares, and you buy specific number at set price per share.

Direct equity is more common at later stages (Series A and beyond) when companies are ready for formal valuation. At pre-seed/seed, SAFEs are simpler and more flexible.

As Elizabeth Yin, co-founder and GP of Hustle Fund, explains: "Getting deal flow & education have been the bigger blockers to date" for new investors. Understanding these instruments is part of education that removes blockers. Communities teach these concepts through structured programming rather than forcing you to learn everything independently.

Valuation Concepts

Pre-Money vs. Post-Money: Pre-money valuation is company value before new investment. Post-money valuation is value after investment. If company has $8 million pre-money valuation and raises $2 million, post-money valuation is $10 million.

Your ownership percentage is calculated against post-money valuation. If you invest $100,000 at $10 million post-money, you own 1% ($100,000/$10,000,000).

Valuation Caps on SAFEs: SAFE valuation caps set maximum valuation at which your investment converts. If you invest with $10 million cap and company's next round values company at $20 million, your SAFE converts at $10 million (more favorable to you).

Caps protect early investors from dilution. Without cap, your SAFE would convert at whatever valuation company raises next round, potentially giving you tiny ownership stake if valuation increased dramatically.

Why Early Valuations Are Somewhat Arbitrary: Pre-seed and seed valuations are educated guesses, not precise calculations. Company has minimal revenue, uncertain product-market fit, and unpredictable future. The valuation reflects market rates for similar companies at similar stages more than fundamental analysis.

This is why you shouldn't agonize over whether $8 million or $10 million valuation is "correct." Focus on whether opportunity is interesting at prevailing market rates for the stage.

How Capital Actually Flows

Individual to SPV: When you commit to invest through community, you sign documents and wire funds to SPV (Special Purpose Vehicle) bank account. SPV is legal entity created specifically to aggregate investors for this deal.

Multiple investors' checks combine in SPV. If 30 investors each contribute $1,000, SPV holds $30,000.

SPV to Company: Once SPV collects all committed capital, it transfers aggregate amount to company bank account. Company receives one check from SPV rather than 30 separate checks from individual investors.

Company issues SAFE or other instrument to SPV representing the aggregate investment. SPV holds this on behalf of all investors proportionally.

Company Spends Capital: Company uses invested capital for operating expenses: salaries, software, marketing, legal fees, and other costs of building business. The money gets spent whether company succeeds or fails. This is why most investments return zero, capital is consumed in operations.

Exit Distributions (Eventually): If company has successful exit, proceeds flow back through same chain in reverse. Company distributes money to SPV. SPV deducts operating expenses and carry (typically 20% of profits). SPV distributes remaining proceeds to individual investors proportionally.

As Eric Bahn, co-founder and GP of Hustle Fund, emphasizes: "For beginners, a bigger startup portfolio is better. It helps with diversification and helps you learn and get reps in. Investing requires practice like everything else." Part of that practice is understanding how capital flows through structures, not just writing checks blindly.

Cap Table Dynamics

What Cap Tables Track: Capitalization tables show all company owners and their ownership percentages. This includes founders, employees (via stock options), and all investors from every funding round.

Your name doesn't appear directly on cap table if investing through SPV. SPV appears as single line. But SPV maintains internal records showing each investor's proportional ownership.

Dilution Over Time: As company raises more funding, new shares are issued and everyone's ownership percentage decreases. This is dilution. If you own 0.1% after seed round and company raises Series A, your percentage drops to maybe 0.07%.

Dilution is normal and expected. It's not bad if company value is increasing faster than your ownership is diluting. Better to own 0.05% of $500 million company than 0.1% of $10 million company.

Option Pool Dilution: Companies create option pools for employee stock grants. These pools dilute existing shareholders including you. A 10% option pool means everyone's ownership drops by approximately 10%.

This is expected and necessary. Companies need options to attract talent. Just understand it's happening.

Exit Scenarios Explained

Acquisition (Most Common): Larger company buys startup. Acquisition price determines value of everyone's ownership. If company is acquired for $50 million and you own 0.02%, your shares are worth $10,000.

Acquisitions can be cash, stock, or combination. Cash acquisitions are cleaner, you receive money. Stock acquisitions mean you receive acquirer's stock (which you might not want).

IPO (Rare): Company goes public and shares trade on exchange. You receive public stock that you can eventually sell (after lock-up period of 6-12 months typically).

IPOs are extremely rare for companies you invest in at pre-seed/seed stages. Most successful companies get acquired before reaching IPO scale.

Secondary Sales (Very Difficult): Occasionally you can sell shares to other investors before exit. Secondary markets exist but are inefficient and illiquid. Buyers pay substantial discounts (40-60% of last round valuation).

Don't count on secondary sales as exit path. They're possible but uncommon and not economically attractive usually.

Failure (Most Common Actually): Company shuts down. Assets are liquidated. Proceeds (usually minimal) are distributed according to liquidation preferences. Common shareholders (you) typically receive nothing.

Your investment value goes to zero. You claim capital loss on tax return.

Tax Implications

Holding Period: Angel investments are almost always held over one year. This means gains are long-term capital gains taxed at preferential rates (0-20% federally depending on income bracket) rather than ordinary income rates.

Capital Losses: When investments fail, you can deduct losses against capital gains from other investments. If no gains to offset, you can deduct $3,000 annually against ordinary income. Remaining losses carry forward to future years.

K-1 Forms: SPV investments generate K-1 forms showing your share of income, losses, and distributions. Most early years show losses as companies aren't profitable. These forms are necessary for tax filing but usually don't show taxable income until exits.

Qualified Small Business Stock (QSBS): Some investments may qualify for QSBS treatment under Section 1202. This can exclude up to 100% of capital gains (with caps) if requirements are met. Consult tax advisor about QSBS eligibility, it's complex but valuable.

The Practical Workflow

Month 0 (Deal Appears): Community surfaces opportunity with pitch deck, company overview, and terms. Founders might present on pitch call or Q&A session.

Month 0-1 (Evaluation): You review materials, attend presentations, conduct lightweight due diligence, and decide whether to invest. Typical timeline is 1-3 weeks.

Month 1 (Commitment): You indicate investment amount through platform. This creates binding commitment that you'll follow through once deal structures are finalized.

Month 1-2 (Closing): Community creates SPV, prepares documents, and sends them for electronic signature. You sign and wire funds within 1-2 weeks.

Month 2+ (Post-Investment): You receive confirmation. Company issues instrument to SPV. You add investment to tracking spreadsheet. Then you wait.

Quarterly (Updates): Company sends updates to investors. Community forwards these to you. You review progress or lack thereof. Most quarters, nothing interesting happens.

Years 3-10 (Eventual Outcome): Company either fails (most common) or has exit (less common). If exit, SPV receives proceeds and distributes to investors after deducting expenses and carry.

As Shiyan Koh, co-founder and GP of Hustle Fund, notes: "Great founders can look like anyone and come from anywhere." The mechanical process of investing is same regardless of founder profile, SAFEs work identically whether investing in obvious or non-obvious opportunities.

Common Mechanical Questions

"When do I actually own equity?" Not until your SAFE or convertible note converts at next priced round. Until then, you own conversion rights, not equity.

"Can I sell my investment?" Technically yes through secondary markets, but practically very difficult. Assume illiquidity until company exits.

"What if company never raises next round?" SAFEs have provisions for this. Often they convert to equity at cap valuation or company reaches trigger event. Specifics vary by SAFE terms.

"How do I track ownership percentage?" You don't directly. SPV owns specific percentage and you own portion of SPV. Effective ownership is your SPV portion times SPV's company ownership.

"What happens if company pivots dramatically?" Nothing to your investment mechanically. You own conversion rights in legal entity regardless of what business it pursues.

The Infrastructure Advantage

Communities handle complexity so you don't have to. They create SPVs, negotiate standard terms, manage paperwork, track ownership, and handle distributions. You focus on evaluation and decision-making, not legal mechanics and administration.

Angel Squad's infrastructure demonstrates operational efficiency: standardized SPV creation for every deal, electronic document signing completed in minutes, consolidated tax documentation (single K-1 covering all SPV investments annually), and automated portfolio tracking. The operational burden is minimal because infrastructure handles complexity.

Understanding mechanics helps you make informed decisions but you don't need to manage mechanics yourself. Modern infrastructure lets you focus on what matters, evaluating opportunities and building diversified portfolio, while professionals handle structural complexity.