Angel Financing: 4 Things Startups Must Know

20 Jul

By:  Sheheryar T. Sardar, Esq.
Sardar Law Firm LLC
New York, New York
Core Practice Areas:  Technology, Corporate & General Counsel, Startup Law, Project Finance, VC/PE, Arbitration/Mediation, Entertainment, and Human Capital
 
 

Angel financing is loosely defined, as it runs the gamut in terms of executions.  We’ve seen angels simply hand a check to a startup; while other angels hire aggressive large law firms with armies of associates working on an angel financing round.

Because the experience with angel financing can vary, it’s important for startups and entrepreneurs to understand some of the basic legalities behind this type of financing.  Below are 4 tips as a starting point.

(1) Understand the Key Business Terms. This is not an option, it’s a necessity in any financing round.  Just because an investor is called an angel does not mean they represent those famed characteristics completely.  For a preferred stock financing (this is most likely to occur when there is an aggressive large law firm behind the angel in a deal) key business terms include:  (1) pre-money valuation; (2) liquidation preference terms; (3) anti-dilution provisions; (4) Board composition; (5) dividend-related issues; (6) vesting imposition on founders’ shares; (7) protective provisions.  Take the time and learn the terms; grab a book or talk to your attorney.  Of course, having a corporate attorney versed in startup financing will be a great help here, but it’s in your best interest to have at least a base knowledge of the business terms.

(2) Push for Convertible Notes. For startups raising less than $800,000, its generally not in the entrepreneur’s best interest to issue equity in terms of preferred stock.  In fact, the entrepreneur is best served by issuing convertible notes, not equity, to angel investors.  First, issuance of preferred stock is costly, complicated and time-intensive.  It involves company valuation and potentially high-dilution for startup founders.  At the initial stages of your company, that’s not what you want.  In contrast, a convertible note would allow the angel to loan the money to the startup, with automatic conversion into equity after the first institutional funding round (Series A).  The convertible note allows the startup to keep their costs low, and defer costly valuation to a larger funding round.  If an angel insists on equity at the outset, push for issuance of common stock – which places the founders and the angel in the same boat – and try to avoid preferred stock.

(3) Never accept terms with personal liability.  It seems common-sense that founders should not be personally liable to angel investors if their company fails (barring fraud of course).  However, it’s a mistake that is commonly made by inexperience startups and entrepreneurs.  There are also inexperienced business attorneys (that don’t work in the startup world) who will request that founders personally take on certain personal liabilities.  Make sure your ready to drop a deal if they are pushing for personal warranties of any kind; and have your own counsel so they can push back on such terms.  The tip here is simple:  never agree to potential personal liability.  It’s not worth it.  And it tells you something about the angel as well; every sophisticated investor knows that angel investing is high-risk, high-reward.

(4) Due Diligence on the Angel.  The hardest thing to do when someone across the table wants to write you a check that can breath life into your idea is to step back, take a moment and think “why are they handing me this money?”  The most common mistake entrepreneurs make in these financing deals is the failure to investigate the person(s) offering to give them money.  The angel isn’t just in the picture for the moment of handing over a check; he or she is essentially married to your company for years to come.  Check references, see what else they  have invested in, and talk to those startups as well.  Make an informed decision as to whether this angel is the right type of investor for your company.  You don’t want to end up with an angel who is a controlling jerk with a bad reputation in the investment world; it could have an impact on future investments, and the future of your company.

For more information on startup legal services, email us at sardar@sardarlawfirm.com or join us for a class taught by Benish Shah and Sheheryar Sardar.

Upcoming Classes:

Pitching Your Company: Hands On Workshop (July 25 7:30-9:00) – Register HERE 

What past students have said:

“Great personalized and relevant advice! Made me and my partner see things in a whole new way. ” – Mike Abadi

Fundamentals of a Startup (August 1 & 8 7:30-9:00 pm) – Register HERE

What past students have said about this class:

Benish and Sheheryar provided many useful insights about the startup world and launching a company. I thought I knew the best way to launch before the class, but they helped fill in the gaps in my knowledge about forming a corporation, raising capital, and other various legal considerations. Highly recommended.” – Chris Macke 

“This is a great class to understand the basics of how to establish and grow a startup from the legal/investment perspectiveBenish and Sheheryar are both passionate about the startup world and are able to provide an angle that most entrepreneurs would not naturally consider.” – Ashek Ahmed

Great breakdown of legal advice for a startup– the information was personalized, relatable and clearly presented. My partner and I expected to walk away confused, but we left knowing the right moves for our business.” – Sisi Recht

 

 

 

 
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