Understanding the Angel Investment Process
How long does it take to gain the investment?
If you are just starting our on the road to seek angel investment, you need to allow time in terms of preparation and accessing investors and you may need to pitch on several occasions before finding interest from investors. So if you have immediate needs for finance, it is unlikely that equity finance is appropriate. As a rough guide, a minimum of 8 weeks is generally needed from reaching agreement in principle to conclude all the due diligence and investment procedures but this can vary tremendously according to the complexity of the deal and the degree of alignment between the investor(s) and the business. However it is worth bearing in mind that it can take considerable time to reach an agreement in principle so from first contact with interested investors to final investment you could take 3-4 months.
Angel Investing requires clear processes to ensure that the interests between your business and your investors are aligned and to reduce risks for both you and your investors, including carrying out relevant levels of due diligence and structuring the deal through legal documents.
Prior to investing, angel investors will normally seek to review all the aspects of the deal. This enables them to investigate the key aspects of the business and the investment proposal before committing to an investment. Research has shown that doing at least 20 hours due diligence considerably increases the chances of a more positive outcome from the investment.
Some investors may decide to commission external technical support, in order to reduce transactional costs of investment, many angels do their own due diligence drawing on their own knowledge base and key business and professional contacts to support their investigations. If they are investing as part of a syndicate, this is normally shared between the investors, each taking on areas where they have the knowledge or expertise or key contacts, generally with a lead angel who will directly interact with you and your business.
There are four key areas where Investors will focus their due diligence and where you should be as helpful as possible to provide clear responses to their questions and relevant evidence- this will help to speed up the process:
- Management – this covers key issues about checking out the teams’ experience and competence; what you and your team, are bringing to the business and your own capacity, passion and commitment to execute the business plan and take the business forward to high growth . This would generally be through interview and dicussions, or looking at PR and LINKED-IN or other relevant social media.
- Finance – the investors will be wishing to ensure there are no “black holes” in the accounts of your business; or areas of the finances of the company that will have an impact on the investment and ongoing growth of the company (such as existing debts); ensuring the projections and forecasts are reliable.
- Legal- this covers key aspects of the business establishment; ownership and shareholding; employment contracts; ownership of IP; existing commercial contracts etc.
- Commercial: this covers issues relating to the Product and Technical issues; market and competition.
Due diligence factsheets for the above are available in the Resources & Links section.
How do Investors Value the Opportunity?
Valuation is a key aspect of the deal negotiation process and determines the share of the business that the investor will own. There is no real science to this, but there are a number of approaches that Business Angels use.
All of the factors above are important in determining valuation ie Management team; business growth potential; IP; defensible competitive position; scalability; market and customers; EIS/SEIS eligibility and exit prospects. The further developed the company is in establishing these factors and determining its longer term value, the more they can attract as a valuation.
There are three methods commonly used for valuation:
- Asset valuation- Looks at the value of assets minus liabilities
- Relative valuation- Looks at similar companies’ valuations in the past
- Discounted cash flow- Sum of future cash flow, with each year into the future discounted more heavily.
The key aspects that investors will be looking for: Have you established a reasonable initial value for your business? What is the basis for your valuation and does this seem realistic and sensible?. Are you prepared to be flexible in your approach to valuation and prepared to negotiate?
It is important to bear in mind that the approach to valuation often determines the ongoing relationship between you as the entrepreneur going forward and your investors.
Deal Structure and Legal documentation
Heads of terms
Also known as a term sheet, letter of intent or memorandum of understanding, this is a document which sets out the main terms of the proposed investment and any pre-conditions to the making of the investment. Whilst generally not legally binding, drawing up a Head of Terms helps to provide clarity for all parties (and their respective advisers) as to the main terms of the deal at an early stage of the process and is a very useful basis for ensuring all relevant due diligence is covered and key aspects of the investment are understood between you and the investors, before detailed drafting and negotiation of the main legal documents takes place. It is important to keep the heads of terms as simple as possible in order to avoid protracted negotiations at this stage.
Key Legal Documents
Once the investment terms have been agreed, these should be integrated into the main legal documents which will typically comprise those set out below:
Investment and shareholders’ agreement – this document sets out the terms of the investment and regulates the relationship of the shareholders once the investment has been completed. It will address the specific rights of the Angel Investor(s), such as rights to appoint directors, to receive information on the business and to veto certain actions of the company as well as usually containing warranties as to the company’s business.
Download model Shareholders Agreement Template and Guidance
Articles of Association – typically, new articles of association are adopted on completion of the funding which will set out the company’s internal regulations and deal with its management and administration. They deal with matters such as transfers of shares, dividends and voting rights, and complement the investment and shareholders’ agreement.
Download model Articles of Association and Guidance
Disclosure letter – the disclosure letter sets out disclosures against the warranties contained in the investment and shareholders’ agreement. Warranties and disclosure are key elements of the transaction documents and will be contractually binding on the parties, this can help to ensure that specific and detailed disclosures are made by the company – as opposed to the often rather general responses which due diligence flushes out. If any warranties are not true, and this is not brought to the attention of the investor(s) prior to completion of the investment, the investor(s) will potentially have a claim against the warrantors for losses which they suffer as a result.
Download the Legal and Technical Guide covering all the key aspects of the Legal Process
You should always obtain legal advice to finalise all documentation related to the investment. For details of Legal firms who are members of UK Business Angels Association, visit the searchable Members & Services Directory.