Individual investors in startup companies are known in small business finance circles as “angel” investors. This term originated not in the well-known epicenters of startup activity, but in the Broadway theater district. To the actors, playwrights and choreographers, wealthy patrons who funded new musical and theatrical productions were called “angels” because they helped the artists' big stage dreams come true.
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In addition to the time-saving advantage of collecting big checks from a fewer number of investors, soliciting wealthy individuals can minimize the administrative burden of complying with securities regulations.
Accredited investors, also known as “qualified investors,” are defined by Regulation D of the 1933 Securities Exchange Act as individuals who have a net worth of $1 million or income of at least $200,000 in the two years prior to investment.
The net worth standards were recently amended by Congress and the SEC to exclude a prospective investor’s primary residence in the calculation.
Entrepreneurs who raise money through accredited investors generally don’t have to put together a costly legal document called an “offering memorandum.” Raising money from non-accredited investors is allowable, but involves considerable legal expertise and compliance with complex federal and state regulations.
While it may seem more difficult for big idea entrepreneurs to obtain checks from wealthy investors, ultimately soliciting non-accredited investors can be the more time-consuming and expensive path to funding success.
Here are five tips for appealing to accredited, angel investors:
No. 1: Select the right business structure. Most angel investors prefer to invest in businesses that are organized as standard “C-corporations.” The primary benefit to investors is C-corps operate with board of directors’ oversight, can issue different classes of stock, and have no limitation on the number of stockholders. Technology businesses that are organized as limited liability companies, partnerships or S-corporations are usually asked to restructure to C-corps before receiving funds from investors.
No. 2: Understand different classes of stock. Most founders of new C-corp businesses receive shares of common stock. Accredited investors, however, are usually smart enough to insist on receiving a separate class of stock, called “preferred stock.” All the terms of a company’s preferred stock are negotiable and different investment rounds are likely to give stockholders different advantages over common stockholders. For example, when a company is acquired, all preferred stockholders get paid back their original investment plus a cash premium before common stockholders.
No. 3: Address investor issues. Entrepreneurs who want funding from investors have to talk about issues that matter to investors. Yes, it’s fun to talk about cool features of new Websites, games, and gadgets but not at the expense of addressing the marketing, partnership and pricing strategies that will make a business successful against its competitors. Accredited investors also want to know how their money will be spent and when a business will reach cash flow breakeven and profitability. Entrepreneurs who are vague about these issues will lose out to other entrepreneurs who know their numbers, their industry and their game plan.
No. 4: Pursue angel investment clubs. Active angels often form clubs to cut down the time associated with reading business plans and meeting with entrepreneurs. Some clubs prefer to invest only in technology companies while others will review new business opportunities from a broader range of industries.
Soliciting angel investment clubs can save entrepreneurs time too. In just one presentation, entrepreneurs may be able to reach dozens of prospective investors. Even better, most clubs require members to be accredited investors and fund at least one small business per year. To find the names of regional angel investment clubs, visit www.takecommand.org.
No. 5: Make it convenient for investors. In my book, entrepreneurs who think their work schedule is more important than a potential investor’s schedule are going to have an empty bank account for a long time to come. Because most accredited investors lead active business and personal lives, they look through business plans during their spare time. As such, entrepreneurs should not expect immediate return phone calls. All email communications should be short and meetings should be set up wherever and whenever it is most convenient for the prospective investor.
Make 2012 the year that you succeed in raising funds for your business!