Raising Project Seed Funds With Angel Investors
Angel Investors
Angel investors are high-net-worth individuals who are willing to invest in developing companies. Apple computer
got its first round of outside capital from an angel. In 1977, an early Intel executive and shareholder invested
$91,000 into Apple and guaranteed another $250,000 in credit lines. At the time of the Apple IPO in 1980, the
angel was allegedly worth $154 million.
Most estimates put the amount of angel capital invested in 1997 in the United States at approxiamately $50 billion.
Of that amount, $40 billion supposedly came from friends and family and was invested primarily in privately held
small businesses. This type of angel money is called "3F money," for friends, family, and fools.
A recent phenomenon is the appearance of professional angels consisting of successful entrepreneurs who have
already exited (that is, enjoyed the fruits of an IPO or sale) and are looking to do it again with another promising
entrepreneur.
Angels vary widely in personality, methodology, and goals. On one end of the spectrum is the unsophisticated
investor who likes a particular entrepreneur or business and views his or her investment no differently than
gambling in a casino. These investors, sometimes called "recreational investors," like the idea of being identified
with a particular company. They enjoy bragging about the investment to their friends at their club or on a golf
course. They typically purchase either common stock or high-yield notes (either convertible or with warrants) and
do not impose restrictions on the entrepreneur. These recreational investors are sufficiently wealthy so that the
loss of the entire investment would not remotely affect them any more than a gambling loss would.
The other end of the angel investor spectrum is the sophisticated angel who views the investment as a business.
While not as sophisticated as a professional venture capitalist, these investors exhibit a significant amount of due
diligence and invest only in businesses they fully understand.
These sophisticate angels tend to purchase preferred stock or convertible notes, and never common stock, so
they will always be senior ot the entrepreneur who holds common stock. Entrepreneurs should expect significant
operating restrictions in any agreement with the sophisticated angel, who thinks and talks like a professional
venture capitalist. It is not unusual for these investors to refuse to invest in a company because no member of
their group has investment experience in that company's type of business.
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The Archangel
Many ange investors operate in groups, the leader of which is called the archangel. The archangel for the
recreational investor is typically the first to invest his money, with the remaining group members following on his
heels. The archangel for sophisticated investors typically arranges for the due diligence for the group and
negotiates all business terms.
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Structuring Deals for Angels
The structuring of the angel transaction will depend upon the nature of probable angels, sophisticated or
unsophisticated.
If your target market is sophisticated angels, you would best approach them with an outstanding business plan
and an impressive management team. You would probably waste your money by creating an offering or
disclosure document prior to obtaining their input since these sophisticated angels will be giving you a term sheet
similar to that prepared by a professional venture capitalist. Only after you have received their term sheet and
finalized your negotiations is it worth your while to create an offering document.
Some companies never create an offering or disclosure document when dealing with very sophisticated angels,
particularly when the group consists of fewer than five investors. Instead, they create a "risk factor" document,
which discloses all investment risks they can think of. This is a much shorter and less costly document to prepare
than a full-offering or disclosure statement.
If your target market is recreational investors, then a full-offering or disclosure statement is advisable. These
recreational investors will typically not negotiate terms. Therefore, you are better off structuring the offering for
them on a take-it-or-leave-it basis. The offering or disclosure document should not be prepared until you have
had informal conversations with these investors to discuss the nature of the transaction and received some
encouragement.
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Investor Terms
Both sophisticated and recreational angel investors want to know that they are being treated fairly, that everyone
gets the same deal.
However, investors who take more risks are entitled to something extra. Therefore, the earliest round of investors
should have some price or other advantage (such as warrants) over later investors.
You may need early investors to provide enough funds to pay legal, accounting, and printing costs for the offering
or disclosure document used in late rounds. Therefore, it is permissable to allow these investors an edge either
through a lower valuation, a warrant, or otherwise.
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Finding Angels
There is no one scientific way to locate angels, except through networking. Many brokers, investment advisors,
lawyers, and accountants are aware of angel networks. You have to locate these intermediaries and try to interact
with them.
When one angel investor turns you down, ask him or her about other angels who might have an interest.
Since sophisticated angels like to invest in businesses they know, try to find other businesspeople who have been
in a similar business. If businesses have recently been sold in your industry, the sellers might be logical angels.
A Web site for angels is now being developed. However, this new site is unlikely to be an important source of
angels for many years to come.
One reason is that angels, like professionally managed venture capitalists, prefer to invest locally. Therefore, a
Web site listing the angels located within your region would be more helpful than a national site.
A second reason is that angels do not want to identify themselves, for fear of being bothered by a multitude of
entrepreneurs. The new Web site accomodates to that concern by keeping the name and address of the angel
secret until the angel approves its disclosure. However, many angels do not trust the secrecy of the Web.
Finally, many recreational angels, who do not view investing as a business, would not like to see themselves listed
on a Web site.
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Web-Site Angels
Angel sites listed on the Internet are:
www.sba.gov/advo - ACE-Net (The Angel Capital Electronic Network sponsored by the U.S. Small Business
Administration)
www.businessfinance.com - America's Business Funding Directory
www.aeeg.org - American Entrepreneurs for Economic Growth
www.businessexchange.com - American Venture Magazing
www.eillc.com/angel.htm - The Angel Network Membership Guestbook
www.bizplanit.com - BizPlanIt
www.brainstorm.co.uk/BVCA/ - British Venture Capital Association
www.businessangels.com.au - Business Angels P/L
www.matchmaker.org - Capital Matchmaker
www.thecapitalnetwork.com - The Capital Network
www.darwin1.ucsd.edu:8000/connect/index.html - CONNECTNet
www.datamerge.com - DataMerge, Inc.
www.eillc.com/what.htm - Entrepreneur Investments, LLC
www.eillc.com/index3.htm
www.eillc.com/
www.evca.com - European Venture Capital Association
www.financehub.com - Finance Hub
www.garage.com - Garage.com
www.ideacafe.com - Idea Cafe
http://strategis.ic.gc.ca - Industry Canada Strategis
www.innovest.org - INNOVEST
www.icrnet.com - International Capital Resources Guide
www.tinvex.com - The Investment Exchange
www.moneyhunter.com - MoneyHunter
www.nvca.org - National Venture Capital Association
www/foothill.net/svcn/ - Sacremento Area Venture Capital Network
www.scor-net.com - SCOR-NET
www.v-capital.com.au - The Venture Capital Marketplace
www.vcapital.com - Venture Capital Online
www.vfinance.com - Venture Capital Resource Library
Most of the sites offer services for the entrepreneur to locate potential angels. Care should be exercised in using
these sites to avoid potential scams. Entrepreneurs are cautioned not to pay up-front fees to the sponsors of
these sites and to have a securities lawyer review any legal documentation.
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Corporate Angels
A growing number of corporations have developed venture capital divisions designed to nurture companies that fit
into the corporate strategy. For example, Intel Corporation supposedly made 100 venture capital investments in
1997, twice as many as the year before.
It is not unusual for large corporations to make large expenditures for research and development for their own
operations. However, many of these research development investments turn out to be less than productive,
primarily because of the lack of internal incentives within the organization.
Corporate investors generally can afford higher valuations because of their focus on "strategic" rather than
financial returns. While some corporate investors seek early-stage opportunities - some even want portfolio
company board seats - others want a more passive role with a company that has worked out the bugs. Intel is
one of the most active corporate venture players, reportedly spending some $300 million on about 100
transaction in 1997. The chip maker generally invests between $1 million and $5 million in each deal. Intel
typically does not want board seats or to manage the day-to-day company operations.
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Angel Networks
The following is a list of angel networks:
Atlanta Development Authority (ADA) - Atlanta, GA - 404-658-7000
Atlanta Venture Forum, Inc. (AVF) - Atlanta, GA - 404-873-8522
Capital Network, Inc. (TCN) - Austin, TX - 512-305-0826
Council for Entrepreneurial Development (CED) - Research Triangel Park, NC - 919-549-7500
Datamerge, Inc. - Denver, CO - 303-320-8361
Environmental Investor's Newsletter - Los Angeles, CA - 213-466-3297/800-995-1903
Indianapolis Small Business Development Corp. (ISBD) - Indianapolis, IN - 317-264-2820
International Venture Capital Institute (IVCI) - Stamford, CT - 203-323-3143
The Investment Exchange - Calgary, Alberta, Canada - 403-208-2964/800-563-5448
Michiana Investment Network (MIN) - South Bend, IN - 219-282-4350
National Association of Investment Companies (NAIC) - Washington, D.C. - 202-289-4336
National Venture Capital Association (NVCA) - Arlington, VA - 703-524-2549
Oklahoma Investment Forum - Tulsa, OK - 918-585-1201
Orange County Venture Forum (OCVF) - Laguna Hills, CA - 714-855-0652
Pennsylvania Private Investors Group - Wayne, PA - 610-975-9430
The Private Investors Network - College Park, MD - 301-405-2144
Rockies Venture Club (RVC) - Denver, Co - 303-831-4174
Small Business Investment Companies (SBICs) - Washington, D.C. - 202-205-7589
Technology Capital Network, Inc. (TCN) - Cambridge, MA - 617-253-7163
Vankirk's Venture Capital Directory - Wellesley, MA - 703-379-9200
Vencap Data Quest - Mountain View, CA - 415-852-9140
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How to Conduct an Angel Offering
Conducting an angel offering requires that you first develop a marketing plan. The marketing plan must identify
who are your potential investors, how you intend to solicit them, and what is your investor's appetite for common
stock, preferred stock, or high-yield notes (with or without warrants). Your marketing plan should also specifiy the
total amount you wish to raise and your company's planned use of the proceeds. (This is your basis Sources and
Uses of Funds sheet.)
Most angel offerings today are conducted under Rule 506 of Regulation D of the Securities Act of 1933. ("1933
Act") if the marketing plan contemplates soliciting wealthy "accredited investors" (defined under Rule 506) and
other sophisticated investors with whom you (or any broker helping you) have a preexisting relationship. If your
marketing plan contemplates solicitation of strangers or any form of advertizing or seminars to attract investors
(sometimes called "a road show"), then you cannot use Rule 506, which prohibits these forms of solicitation.
Likewise, you will not qualify for Rule 505 or any of the "private placement" exemptions contained in the 1933 Act
if your marketing plan contemplates the soliciting of strangers, advertising, or conducting seminars.
Instead, your angel offering will have to be conducted as a public offering under Rule 504 and in compliance with
the Small Corporate Offering Registration (SCOR) state rules, assuming that you intend to raise no more than $1
million over a 12-month period. If you do intend to raise more than $1 million over a 12-month period, you will
have to comply with Regulation A of the 1933 Act or register your offering with the SEC.
Each of these SEC rules and forms can be obtained from the Security Exchange Commission.
A "general solicitation" is defined in SEC Regulation D as follows:
Limitation on manner of offering. Except as provided in Rule 504, neither the issuer nor any person acting on its
behalf shall offer or sell the securities by any form of general solicitation or general advertising, including, but not
limited to, the following:
Any advertisement, article, notice, or other communication published in any newspaper, magazine, or similar
media or broadcast over television or radio; and
Any seminar or meeting whose attendees have been invited by any general solicitation or general advertising
(subject to a minor exception).
In general, you should, if possible, tailor your marketing plan to comply with Rule 506 to avoid the hassle and
delay of dealing with federal or state regulatory agencies. Unlike Rules 504 and 505, an offering under Rule 506
avoids the necessity of complying with the registration provisions of state securities laws, and the amount of
capital you can raise is not limited.
If you cannot comply with Rule 506 because you intend to engage in a general solicitation or intend to sell to more
than 35 unsophisticated investors (as permitted by Rule 505) or more than 35 non-accredited investors, the next
best choice is the Rule 504/SCOR offering exemption, which was designed as a "do-it-yourself" offering to
facilitate raising small amounts of capital.
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Securities Act of 1933
The offer and sale of both debt and equity securities is a highly regulated transaction. The states adopted
securities laws in the late-nineteenth century. These laws are also called "blue sky" laws because they were an
attempt to regulate promoters who were promising investors the "blue sky."
The 1933 Act was the first federal securities law. Congress adopted this law in response to the Depression (which
it considered the result of the 1929 stock market crash) and various abusive and fraudulent securities practices
that had occurred during the 1920s.
Until 1996, the 1933 Act did not preempt state blue-sky laws. Thus, any offer or sale of a security had to satisfy
the applicable state law as well as the 1933 Act. In 1996, Congress amended the 1933 Act to preempt the
registration provisions (but not the antifraud provisions) of state blue-sky laws for transactions under Rule 506 as
well as certain other transactions in publically traded securities. However, even after the 1996 law, the antifraud
provisions of state blue-sky laws still apply and notice of Rule 506 transactions still may be required to be filed
with the appropriate states.
Most federal and state securities laws can be divided into two main sections:
Registration provisions
Antifraud provisions
Although compliance with Rule 506 (as well as Rules 504 and 505) exempts the angel offering from the
registration provisions of federal and (in the cse of Rule 506) state securities laws, the antifraud provisions of
these laws still apply. To comply with these antifraud provisions, a full-disclosure document should be furnished to
your angel investors prior to your receiving any money from them or legally binding them. Such a disclosure
document should contain a frank discussion of the "risk factors" of your business.
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The Private Placement Choices
In the following offerings, no general solicitation is permitted and marketing is limited to qualified investors with
whom there is a preexisting relationship with the company or broker solicitating the sale:
Rule 505
Primary Advantages: Can sell to 35 unsophisticated persons and unlimited number of accredited investors; no
federal review required.
Primary Disadvantages: Limited to $5 million over a rolling 12-month period; no general solicitation permitted;
professional investors may extract onerous terms because of illiquidity; must comply with state securities laws.
Rule 506
Primary Advantages: Unlimited dollar amount can be sold to 35 sophisticated and experienced investors in
financial and business matters and an unlimited number of accredited investors; no federal review is required and
registration provisions of state securities laws are preempted, provided notice is given (if required by state).
Primary Disadvantages: No general solicitation is permitted; professional investors may extract onerous terms
because of illiquidity.
According to SEC Rule 501, adopted under the 1933 Act, an "accredited investor' includes, among others, the
following individual investors:
Any natural person whose individual net worth, or joint net worth with that person's spouse, at the time of his
purchase exceeds $1,000,000; and
Any natural person who had an individual income in excess of $200,000 in each of the two most recent years or
joint income with that person's spouse in excess of $300,000 in each of those years and has a reasonable
expectation of reaching the same income level in the current year.
The following other requirements must be satisfied under both Rule 505 and 506:
Disclosure of certain information (unless all purchasers are accredited investors)
Restrictions on resale of the securities
Notice filed with SEC and state blue-sky regulators
Antifraud provisions of the securities laws will require disclosure even in an all accredited investor offering.
Private placements may also be effectuated under the judge-made case law decided under Section 4(2) of the
1933 Act and also under Section 4(6) of that law (dealing with sales solely to accredited investors). Angel
offerings to individuals under the case law of Section 4(2) are infrequent because of the conflicting court decisions
and the lack of any preemption of state securities law. Section 4(6) of the 1933 Act is likewise infrequently used
because it is more restrictive than Rule 506.
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The Public Offering Choices
General solicitation is permitted and there is no investor qualification for these public offerings:
Public Offerings Registered with SEC
Primary Advantages: Better terms for founder than private placements. Unlimited marketing where blue-skied; no
investor qualifications.
Primary Disadvantages: Cost (typical rangee: firm commitment underwriting, $350,000 to $500,000;
self-underwritten, $100,000 to $250,000, plus underwriting discount and commissions, and expense allowance).
Audited financials required.
Public Intrastate Offerings Registered in One State (exempt from federal but not state registration)
Primary Advantages: Same as above. No federal review required.
Primary Disadvantages: Can only be marketed in one state. Must comply with state registration requirements.
Public Regulation A Offerings (exempt from federal registration, but federal review required)
Primary Advantages: Can "test the waters" before filing in some but not all states. Audited financial statements
not required for federal review, unless otherwise available (however, states may still require audited financials);
less disclosure required than in SEC registered offerings; can use question-and-answer format; unlimited
marketing where blue-skied.
Primary Disadvantages: Limited to $5 million in rolling 12-months, including no more than $1.5 million in
non-issuer resales; still must be reviewed by both federal and state regulators; professional help required; cost in
excess of $50,000 (typical range: $75,000 to $150,000).
Public Rule 504/SCOR Offerings
Primary Advantages: Same as Regulation A, except no federal review required, and unaudited financial
statements permitted in most states; can be completed without professional help and is therefore least expensive
of all offering forms.
Primary Disadvantages: Limited to $1 million in 12 months; still must be reviewed by state regulators; higher risk
of defective disclosure and personal liability if prepared without professional help.
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Type of Offering
The type of offering you choose depends on the following factors:
How much money do you wish to raise?
Does your marketing plan require that you generally solicit potential investors?
Where do you wish to sell the securities?
The most important factor in choosing the type of offering is the method of marketing the offering to customers. If
you want to be able to approach strangers or to advertise in newspapers, you cannot use offerings that prohibit
general solicitation, as noted above. In private offerings, the SEC prohibits any solicitation of any investor with
who the company or its broker does not have a preexisting relationship. (THIS is where the broker brings value in
most cases).
If you need to generally solicit strangers and the investors are located in more than one state, then an intrastate
public offering - an offering limited to one state, which is exempt from 1933 Act registration - is inappropriate for
your company. Consequently, you must register your offering with the SEC or use a Regulation A offering.
Most self-underwritten and best-efforts public angel offerings are for less than $5 million. Accordingly, your
practical choices are to use a Regulation A or an intrastate offering registered with one state. If the offering is for
$1 million of less (measured over a rolling 12-month period), the SCOR offering may permit you to avoid federal
registration and to file a question-and-answer SCOR form with the states in which it is to be made.
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Control Personal Liability
If you violate either the registration or antifraud provisions of federal securities laws, you may be personally
liable. This is true even though you have formed a corporation or other limited liability entity and that entity
received all of the sale proceeds. This is because of provisions in federal securities laws (and some state laws),
that impose personal liability on control persons. The only defense to such control personal liability is to prove that
you acted in good faith and after reasonable investigation you nevertheless still could not prevent the violation.
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Raising Project Seed Funds with Angel Investors - Mar 2000
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