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If you own a start-up business, you may have encountered the phrase ‘angel investors’. Angel investors are a special kind of equity provider. Depending on your business needs, angel investors may be the ideal way to enhance your business’ growth. This article will explain:
- what are angel investors;
- the advantages and disadvantages of using angel investors; and
- some commercial and legal considerations you should keep in mind.
Angel Investors
There is no legal definition of an angel investor. However, in business terms, an angel investor refers to a certain kind of investor that provides early-stage businesses with cash in exchange for equity shares in the business. You can refer to this investment as an angel investment or a seed investment.
Angel investors can act as individuals, businesses, or groups. Where there is more than one angel investor, it is usual to find a single angel investor acting as the lead investor (the ‘lead angel’). The lead angel will coordinate the investment deal on behalf of the other angel investors. Together, a group of angel investors is called a syndicate.
Typically, angel investors take small stakes in a company, not exceeding 25% of the business’s total share capital. In addition, as an investment condition, the angel investor may appoint one or more individuals to your company’s board of directors.
Regulation
There are no laws specifically regulating the conduct of angel investors. Instead, angel investors must abide by general investment laws and conduct.
Angel investors are represented by the UK Business Angels Association (UKBAA). The UKBAA is the recognised trade body for angel investors. There is no requirement that all angel investors must be members of the UKBAA. However, as a business owner, you may consider only dealing with angels that are members of UKBAA. This helps ensure that they are abiding by industry best practices.
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Most angels invest in businesses that have demonstrated a degree of success. Commonly, angels call this evidence of a minimum viable product (MVP).
An MVP does not necessarily need to be the final product. However, the extent to which your business may or may not have an MVP will depend on the business in question. For instance, if you are developing a new financial technology product and have developed a beta version that is mainly functional, angels may be satisfied that there is an MVP. On the other hand, if you have an idea for a fintech product but have not actually written the code, this is unlikely to attract angel interest.
Structuring an Angel Investment
The exact structure of the angel investment can take many different forms. However, the smallest investments tend to be no less than £50,000, and the largest rarely exceed £500,000.
In nearly all cases, angels will seek an equity stake in your business. This is because equity promises the biggest upside compared to a loan. If your business doubles in sales, this means the value of the equity likewise doubles. Likewise, if your business fails, the value of the angel’s equity will be wiped out.
Angel investors may seek to structure their equity investments via:
- ordinary shares;
- preference shares; and
- convertible shares.
Ordinary Shares
If your business grants the angel ordinary shares in your business, they will have the same rights as you relative to their stake in the business. The most important rights are the rights to share in the profits and the right to vote on shareholder matters.
Preference Shares
Unlike ordinary shares, if you issue preference shares to angels in your business, you are granting them different rights than the ones you enjoy. The difference in rights commonly relates to the right to dividend payments only.
As the name suggests, preference shareholders have preferred rights to dividend payments ahead of ordinary shareholders. You may structure the dividend amount in two ways, including a right to:
- receive a portion of all dividends first; or
- be paid a fixed amount per share ahead of ordinary shareholders.
In the first case, the angel investor may stipulate that all preference shareholders are entitled to £2 for every £1 the company pays to ordinary shareholders. If the business directors declare a £10,000 dividend after you turn a profit, £3,750 would go to ordinary shareholders and the rest to the preference shareholders.
In the second case, the angel investors may stipulate that each preference share entitles the holder to £1 in dividends. Provided your company declares dividends, the business must pay all the preference shareholders their entitlement before it can pay out the ordinary shareholders any profit remaining.
Convertible Shares
Angel investors do not look for convertible shares as frequently as they do ordinary and preference shares. That said, convertible shares essentially operate as a loan. It grants the convertible note holder the right to convert the loan amount into equity at a pre-agreed rate upon pre-agreed conditions.
Key Takeaways
Angel investors are a key source of financing for start-up businesses. However, angels tend to target businesses that have evidence of a commercially viable market product. In exchange for giving your business cash to grow, angel investors will obtain an equity stake in your business. This means they will share in the profits and influence the company’s direction.
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Frequently Asked Questions
An angel investor is generally an investor that invests in early-stage businesses. Typically, they acquire a minority stake in the business.
You can reach out to United Kingdom’s Business Angels Association (UKBAA) members through the UKBAA’s member directory.
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