Table of Contents
In Short
- Angel finance offers funding in exchange for equity, supporting business growth.
- Key legal issues include shareholder agreements and equity dilution.
- Convertible debt and investor roles should be clearly outlined.
Tips for Businesses
Before accepting angel finance, ensure your shareholder agreement is thorough, clearly defining investor roles. Protect your business by reviewing equity dilution risks and securing legal advice to avoid disputes.
Angel finance, provided by wealthy individuals or networks of investors (angel investors), plays a significant role in the growth of many small businesses and startups. It typically involves high-risk, early-stage investment in exchange for an equity stake in the company. If you want to expand your small business significantly, angel finance can offer capital, valuable guidance, industry connections, and mentorship. This article will explain what angel finance is and the legal considerations you should consider if you are considering funding your small business’s expansion through angel investment.
What Is Angel Finance?
Angel finance involves individuals, known as angel investors, providing funding to startups or small businesses in exchange for equity. Angel investors usually invest their personal funds and tend to be involved in the earlier stages of a business’s lifecycle.
Typically, startup founders seek angel investment to grow and scale their operations. However, small businesses can also benefit from this form of financing at various stages of their development. You may turn to angel investment when you are looking to expand your small business, develop new products, or enter new markets. If you have a proven concept, angel investment can provide the financial boost you need to take on larger projects without relying on traditional financing options such as bank loans. Beyond capital, angel investors can provide mentorship, offering guidance on entering new markets or scaling and helping you navigate expansion challenges.
How Does Angel Investment Work?
Typically, an angel investor injects money into a business in exchange for equity to help it grow. These investors may also provide mentorship, advice, and networking opportunities.
For example, suppose your small business requires £100,000 in early-stage funding to expand its operations. In that case, an angel investor might contribute this amount in exchange for a 20% equity stake in your company. The investment amount and the percentage of equity they require can vary depending on factors such as your business’s industry, concept, pitch, team, and financial projections.
It is important to remember that seeking angel finance is competitive. Many other businesses will be competing for the attention of potential investors, so you must ensure that your concept, pitch, and projections are strong.
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Legal Considerations for Angel Finance
1. Drafting Shareholder Agreements
One of the most critical legal aspects of angel finance is the shareholder agreement. This document outlines the rights and responsibilities of the business and the angel investor. It will clarify aspects such as:
- the investment amount;
- the percentage of equity your investors require;
- voting rights; and
- exit strategy.
Without a solid shareholder agreement, misunderstandings about the investor’s role in business decisions or profit distribution could arise. To safeguard your business interests, having a lawyer review your shareholder agreement is best practice.
2. Equity Dilution
Equity dilution occurs when a business gives portions of its equity to new investors, reducing the ownership percentage of existing shareholders. When engaging with angel investors, you must be cautious about how much equity you offer. Giving away too much can dilute your control over the business.
It is crucial to negotiate terms that prevent excessive dilution while still making the investment attractive to the angel. A lawyer can help you structure the agreement to maintain balanced control over decision-making.
3. Convertible Debt Agreements
Sometimes, angel investors (and other private investors like venture capitalists) may provide funds as convertible debt. Convertible debt is a loan that converts into equity after a particular milestone, such as reaching a revenue target or securing additional funding. A convertible debt agreement must clearly define when and how the conversion happens and at what valuation.
Without clarity, disagreements may arise over whether your company has met the conversion terms or the equity value you exchange. A well-structured convertible debt agreement will mitigate the risk of such disputes arising.
4. Investor Involvement and Control
Angel investors often want some control over critical business decisions, even though they are minority shareholders. It is vital to define the investor’s involvement in your business. You should carefully consider how much control you will relinquish and explicitly document this in your investment and shareholder agreements.
Key Takeaways
Angel investors can provide your business with capital and strategic support, helping you to expand it and enter new markets. If you want to seek angel finance, there are several critical legal considerations, including carefully reviewing the shareholder agreement and clearly defining your investor’s role in decision-making. It is best practice to seek legal advice. A lawyer can help you mitigate risks, avoid legal disputes, and understand your obligations.
If you require legal advice about angel investment or funding your startup, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
You should ensure that the shareholder agreement covers voting rights, profit distribution, equity dilution, and exit strategies.
Your small business can benefit from angel investment at various stages of its development. You may turn to angel investment when you are looking to expand, develop new products, or enter new markets. If you have a proven concept, angel investment can provide the financial boost you need to take on larger projects without relying on traditional financing options such as bank loans.
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