Seeking an Angel Investor for Your Business? Here's What You Need to Know
Soliciting an angel investor for your business could help your fledgling idea take flight, but if you fail to take some precautions, you could end up with your idea stolen, your business taken from you, or even in jail.
Angel investing is one of the most talked-about funding options for small businesses. While every entrepreneur wants to get angel investment, few know where to even start. Angel investors are relatively rare. Not only are they difficult to find, but they can be incredibly picky about the investments that they participate in. At the time of this writing, Angel investors have more deal opportunities than they have ever had, which allows them the flexibility to have their pick of the litter.
If you are going to solicit Angel investment for your company, you need to have a strategy.
The Facts
The Center for Venture Research estimates that U.S. angel investors invested $19 billion in 55,000 deals (about 35,000 small businesses) in 2008. Many of the investments were in start-up or very early-stage companies. This number is increased in the last eight years.
Angel investing is an active and essential part of the American economy. In 2012, angel investors funded over 67,000 companies in the US and invested $23 billion in these businesses.
Much angel investing is done through organized angel groups whose members work together to identify investment opportunities, conduct due diligence, monitor the companies’ progress and provide support in many other ways. Golden Seeds is one of the largest and most active angel groups in the country.
Who are Angel Investors
Most Angel investors are individuals who are successful in their own right and choose to invest in companies that either provide an attractive investment opportunity or that solve some problem that that investor faces, whether it is personal or business related.
Not all angels are made equal; some are content to be passive investors, while others are more active, taking seats on the board and providing ongoing support to the company. However, for an angel to be successful there are a number of common attributes:
- Genuine independent wealth
- An understanding of their own appetite for risk and a willingness to accept risk
- An ability to assess entrepreneurs and make decisions based on a combination of gut feeling and due diligence
- A willingness to step back and let those in whom they have invested take control and make mistakes with their money
- A readiness to adapt to new information and new technologies
- An understanding of the essentially illiquid nature of angel investment
- The ability to be pragmatic, patient and have realistic expectations
- The experience of having been there before i.e. have experience of growing a young company
- An awareness of their own strengths and weaknesses to be able to know how they can add value to the business
- Access to networks that can assist young businesses to grow
- The desire, interest and energy to make a difference. Seven out of 10 angel investments are made within 50 miles of the angel's home or office.
The Law
While Angel investors can be anybody that you know personally, the Securities and Exchange Commission (SEC) has very strict rules about soliciting people that you do not have a personal relationship with. Failure to abide by these laws cannot only result in harsh fines, but can actually result in criminal penalties, including jail time.
If you are going to be soliciting angel investors, it is critical to work with a knowledgeable attorney who has experience handling capital investment matters. Remember, ignorance of the law is not a defense. If you violate securities laws, which are notoriously complex, your misunderstanding of the rules will not protect you.
If you are going to be soliciting individuals that you do not know, you need to ensure, at the very least, that they are an "accredited investor." An Accredited Investor is the legal term used to define somebody who meets the SEC's definition of someone who is legally able to invest in an early stage company without requiring the company to make financial disclosures. Most commonly, these are individuals that have a net worth greater than $1 million (not including the value of their home) or make more than $200,000 per year (or $350,000 per year for a married couple). If you are trying to get money from somebody that you do not have a personal relationship with that does not meet the qualification of an Accredited Investor, chances are you have probably already committed to securities violation.
Do not try to play fast and loose with the SEC. Be sure to have a strategy for soliciting potential angel investors and consult with an attorney who is knowledgeable regarding securities laws to ensure that that strategy is legal.
Getting an Angel Investor to Invest in Your Business
Pitching to an angel investor is not simply a handshake deal. The angel will most likely want to have a written term sheet agreed upon before legal documents are ever drafted. The term sheet will include important points such as the amount of the investment, the percentage of the company being purchased, and voting rights for the angel investor. The angel may also require other clauses that may make no sense to you. These can include provisions for preferred stock, participation, convertible debentures, and remedies for failure to meet performance goals. You should understand what these mean before you ever agree to sell an interest in your company to an angel investor. It is not uncommon for an "angel" to be a devil in disguise.
Once you've agreed to a term sheet, you'll need to have an attorney draft the paperwork to ensure that the investment is properly recognized and categorized for corporate, accounting, and securities purposes. These documents are typically dozens of pages long, and while much of it will look like boilerplate provisions, you should spend the time and money to have an attorney walk through the provisions so that you have a full understanding of what you're getting into.
Getting an Angel Investor OUT of Your Business
Many angel investments can go south. In a best case scenario, your angel investor will want to have an "liquidity event" in a few years to allow them to cash out on their initial investment. However, if your company is not doing so well, you or the investor may want out of the deal. Ideally, this is something that you've hammered out in your investment documents, but if you haven't, the process can be painful and may require that your company write a significant check to get out of the deal.
If you are seeking an angel investor for your company, there many factors to consider which are not listed here. You will absolutely need legal advice to assist you in the process. If you do not already have an attorney, please give us a call. At The Watson Firm, we handle a number of legal issues for current and aspiring entrepreneurs, including helping you to seek outside investment for your new idea. You can complete the form listed on this page or give us a call at 20-545-7278.