Our last post discussed angel investing from the perspective of the entrepreneur. This week, we pose some of the issues that angel investors should consider when deciding whether to invest in a new venture.
The Prospectus and Subscription Agreement
When deciding whether to invest in a new venture, the first step is to read the offering prospectus and subscription agreement. These documents, if properly prepared, should include the following key points for your consideration:
- The total amount of the offering and the minimum investment required by each investor;
- What type of security you will receive for your investment (common stock, preferred stock, warrants, options);
- How the company plans to use the investment;
- A detailed description of the company with information similar to a business plan, including any revenue and/or projected revenue, biographies of the executive officers and key management personnel, description of the competition, risk factors and financial statements; and
- Information about whether there are any plans to register the shares from the offering.
Who Else is Investing?
Be sure to get a feel for what kind of investments they are getting from others. It should raise a red flag if the company is raising very small amounts of money from many investors. It is easier to convince a circle of friends, family and friends of friends to invest $1,000 than it is to convince them to invest $25,000.
Perhaps equally as important, you should inquire about management’s personal investment. Most angels agree that one of the biggest barriers for a company raising capital is if a founder or executive has not invested his or her own money into the venture. Sure, a founder brings a great deal of non-monetary value to the company, but if he or she does not believe in it enough to invest money, why should you invest yours?
Read the Risk Factors
No one likes to read pages and pages of risk factors, especially when they seem to be boilerplate, but the risk factors often contain key information about a company’s barriers to success. Risk factors will generally contain detail about federal, state and local regulations that can affect a company’s success. For example, if a green energy company is heavily dependent on current government subsidies and tax incentives, any changes in these incentives may significantly alter the company’s course of business. Similarly, the risk factors contain important information about the offering itself, like whether the money you invest is immediately released to the company or if investments will remain in an escrow account until a minimum amount has been raised — the latter being a safer investment.
Understanding the Details
Some of the most important details to consider are the following:
- How is the investment being used? Are they paying a broker a commission on investments, and if so, how much?
- How will future rounds of financing affect your interest? Most offerings do not offer any anti-dilution protection. Consider how your interest will be diluted with later rounds of funding.
- Do your due diligence. Read carefully through the company’s business plan and financial information. Get to know management. Consider a more hands-on approach if you think your background is suitable for a board or consulting position. Many startups are looking for the industry experience of angels as much as they are looking for money.
- Do not get involved with a company that is not complying with SEC regulations. All offerings are subject to SEC rules or must fall within the rules’ limited exemptions. If there are questions about whether a company is properly complying with SEC requirements, do not invest.
The attorneys at Horwitz + Armstrong, LLP have worked as advisors to angel investors and have assisted many companies in raising early-stage capital from angels. For more information about legal considerations before investing, contact Larry Horwitz at firstname.lastname@example.org.