Investing in a Business | Angel Investing for the Non-Angel

Authored by Bryan Springmeyer Bryan Springmeyer is a California corporate attorney who represents startup companies and investors. The information on this page should not be construed as legal advice.

Tweet

If you're interested in investing in a business, but don't necessarily have experience in angel investing, this article explains some of the basics of how these investments are accomplished.

Terminology. if you're not familiar with the term "angel investor", it is the name used for private individuals who invest in businesses. If you want to search for more information about these investments, you should be looking for information about angel investments, seed round transactions, startup capital, or seed capital.

Costs. You'll want to find a lawyer that frequently works with venture capital or securities. A regular business lawyer may not have dealt with these transactions. There are some important considerations for the investor, and the business owners for that matter, that really should be represented by someone familiar with these transactions. Lawyers mean legal fees, which makes investing in a business a transaction that is typically only done on a certain scale. Many lawyers (including myself) and investors standardize smaller investment transactions to reduce the costs of the transaction. This can make the transaction available on a smaller scale, but it may still cost a couple thousand dollars in legal fees, even for the smallest transactions. Angel investors often belong to a network and syndicate their investments, meaning that several investors come in on one transaction, spreading the legal costs out. If this is an option for you, it could make the transaction more feasible/less cost prohibitive.

Securities Law. If you are using the word investor, securities are involved. Even a partnership interest can be a security if there are restrictions on a partner's right to control the company. This means that securities laws are involved. There are federal securities laws and state securities laws. The federal securities laws are structured to require registration generally, but provides exemptions to registration. Registration is a very costly process, so most transactions short of public offerings are structured to fit within exemptions. If they are not structured correctly, the seller, or issuer, of the security may be subject to civil and criminal penalties. For smaller transactions between parties with a preexisting relationship occurring solely in California, I use the intrastate offering exemption for Federal Securities Laws and the exemption provided in 25102(f) of the California Corporations Code for the state laws. This requires minimal filing and can be accomplished relatively inexpensively. For interstate transactions that implicate federal securities laws, the exemptions used may require the investor to be an "accredited investor," which, at the time this article was written, means their wealth is valued at $1 million or annual income is $200,000.

The Transaction. Typical seed round transactions use as the instrument Convertible Notes or Preferred Stock in a corporation. If the business you are interested in investing in hasn't yet created a business entity, it would not be much additional work to incorporate it. If the business has already formed some type of entity other than a corporation, such as a limited liability company (LLC), the transaction could provide the investor with ownership interest in the LLC, and make the founder(s) the manager(s) of a manager-managed LLC. Alternatively, the company could reincorporate as a Delaware corporation, the standard vehicle for venture scale startups.

Convertible notes are loans that allow the creditor to convert the loaned amount and interest to equity. Preferred Stock is a class of equity with liquidation preference over Common Stock, which gives the holder a fixed dividend and other rights and privileges, and allows the holder to convert to Common Stock. Investors negotiate other protections and rights:

• Opportunities for future investment;
• Anti-dilution provisions;
• Voting rights to ensure the company does not take certain actions without the investor's approval;
• Access to the premisis and financial information;
• Redemption rights (which require the company to buy back the stock at a certain point); and
• Registration rights (which require the company to register the securities to make resale more available. These are uncommon in seed round financing).

A variety of common terms are available for the "term sheets" which are a summary of the fundamental terms of the proposed deal. Term sheets are negotiated between the investor and company until an agreement is made. We have created a term sheet generator which is available for free on our website. You can use the platform to review the terms that are commonly negotiated in seed round equity financing.

For a great article by a great author on this subject, check out Paul Graham's "How to Be an Angel Investor".

Related Articles: Considerations in Angel Investment Deals

Representation:  Investment Deal Structuring Business Formation Representation