ANGEL INVESTMENTS POINTS TO CONSIDER, FROM A LEGAL PERSPECTIVE, WHEN FLYING LIKE AN ANGEL The author lists five points which would give any angel investor a helpful start at prudent risk management in order to protect his or her legal position vis-à-vis an investee company This author has observed an increased interest in angel investments in the past few years during which more...
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ANGEL INVESTMENTS POINTS TO CONSIDER, FROM A LEGAL PERSPECTIVE, WHEN FLYING LIKE AN ANGEL
The author lists five points which would give any angel investor a helpful start at prudent risk management in order to protect his or her legal position vis-à-vis an investee company
This author has observed an increased interest in angel investments in the past few years during which more angel investment clubs and syndicates have been formed. With a growing community of start-up companies in the technology and sustainability sectors with some becoming unicorns and going onto successful listings on public markets, individual high net worth investors are making very early stage investments a part of their investment strategy as they seek to be involved in the emerging start-up ecosystem. Angel investors can offer monetary support and strategic guidance to the entrepreneurs who also benefit from the mentorship and experience of individuals who have achieved success with their own companies and businesses. These investors take a punt at a very early stage of a start-up's lifecycle in order to support interesting ideas and innovations so that the start-up can continue until its next funding milestone. However, during the excitement of participation in a start-up's journey, angel investors and companies often forget or overlook various matters that may be considered trivial at an early stage but may become weighty issues further down the journey together. Given the high risk involved at the time of investment (with high returns coming much later, if the investee company is successful), it would be prudent for such angel investors to consider the following when investing in a start-up in Singapore, India or elsewhere, in order to better protect their position whilst being excited at supporting the start-up:
A) BASIC DUE DILIGENCE
It is always helpful to request for the incorporation documents to confirm the form of the legal entity (i.e. partnership or corporate entity etc.), where the company is incorporated, its existing directors and shareholders and also to review the existing capitalization structure of the investee entity. A review of these documents would help to verify the existence of the company, founder(s)' involvement as well as provide visibility over how the company's equity holdings have been structured. Gaining information on the place of incorporation and mode of investments (debt or equity) would also be helpful to the angel investor in determining if there is any particular tax implication the angel investor should consider prior to investing (and later if there is an exit).
B) LEGAL DOCUMENTS FOR INVESTMENT
Prior to making the investment, an angel investor should ask for the transaction documents documenting the terms of investment. Such documents would typically include a subscription agreement (setting out terms of investment) and shareholders' agreement (governing the rights and obligations of parties). There may be some start-ups that have not entered or intend to prepare such documents at this stage in order to minimize costs until a bigger round is to be raised. Whilst this approach is understandable, in such instances, this author would suggest that the angel investor at least provides (or requests) a letter of offer containing the key terms that are essential to the angel investor before making the investment - such letter can contain information on the legal name of the entity, amount of investment, company's bank account details and what the investment monies would be used for (for alignment on purpose of investment). This author would further suggest that an angel investor should look at transferring investment monies to a corporate bank account entity and not to a personal bank account (in order to avoid risk of any scams, frauds or swindles).
Getting legal counsel involved at this stage (despite reservations about costs) is often helpful in obtaining basic information on the company's corporate standing, preparation of documents and review of points critical to the investor or even identifying any red flags if possible.
C) INTELLECTUAL PROPERTY ASSIGNMENT
Given that several start-ups are in the technology or innovation space and founded by founders with a technology background or unique skillset, the intellectual property (including any intangible assets or technical knowhow) would be a critical asset and fundamental to the growth of the investee company. As such, an angel investor may wish to request to review the intellectual property assignment agreements and employment agreements (to confirm if there are intellectual property assignment clauses therein) that assign or novate all intellectual property relevant to the business, to the investee company. This would also help create proper documentation that benefits the company in future fund-raising rounds when investors ask to perform due diligence on the intellectual property owned by the company.
D) TAG-ALONG RIGHTS
One right this author would encourage angel investors to obtain would be tag-along rights (in the investment documentation or the Company's constitution) in the event the founder(s) were to sell their shares to a third party at a later stage. As angel investors are often investing in the capabilities of the founders and management team, such angel investors would not like to be left stranded in the event the founder(s) were to sell their shares to a third party. It may therefore be worth requesting for tag-along rights such that any founder intending to sell his or her shares would be obliged to include the proportionate equity stake of the angel investor in any proposed sale to a third party.
E) DIRECTORS' SEAT AND D&O INSURANCE
Some angel investors may occupy a board seat in order to better mentor the founders and guide the investee-company in its growth journey. The investor's name could be used in the company's presentation deck or website when the company pitches to future investors. As such, one's reputation may become adjoined to that of the company. It should thus be noted that a director owes fiduciary duties to act in the best interests of the company and may face claims from stakeholders (for any reason) whilst assisting in steering the company through various challenges in its life-cycle. As such, the angel investor-director may wish to consider obliging the company to provide a deed of indemnity to the angel-investor director in order to indemnify against any third party claims made against the director. It may even be helpful for the angel investor to require the investee company to subscribe for Directors' and Officers' Insurance (D&O insurance) which can benefit the board of the company in the event of any third party claims.
The above considerations are a non-exhaustive list and there could be other legal, strategic and commercial considerations involved when one is looking at becoming an angel investor and making angel investments. Legal assistance and guidance is always helpful and advised when one is looking at making investments in private entities. This author however hopes that the above 5 points would give any angel investor a helpful start at prudent risk management in order to protect his or her legal position vis-à-vis an investee company especially when one is looking at investing time and monies to the start-up (and building a portfolio of investments in other start-ups) over time.
Disclaimer – The views expressed in this article are the personal views of the author and are purely informative in nature.