If you are a startup founder seeking to fuel your enterprise’s growth with funding, understanding the intricacies of angel investing contracts, term sheets, and agreements is essential. This comprehensive guide will help you navigate the complexities of such legal documents, ensuring you are well-prepared to engage with angel investors in Canada.
Decoding Angel Investment
Before we delve into the technicalities of angel investment contracts, let’s understand the basic concept of angel investment. Angel investing is typically the second step in the fundraising ladder for startups, following the bootstrapping phase. It involves High Net-worth Individuals (HNIs) – known as angel investors – providing startups with the necessary capital, often in return for equity.
Angels usually invest between $5,000 to $250,000, often referred to as seed money. While the funding size may vary, the equity demand from angels generally ranges between 10% to 20%. These investors often provide essential business mentorship in addition to funding, making them valuable partners in the early stages of a startup’s growth.
Evolution of Angel Investing
Angel investing has seen a significant evolution over the past few years. Today, angel investors are not just focused on providing funds but also aim to reduce transaction costs while increasing opportunities and returns. One way they achieve this is by pooling assets, which allows them to share risks, leverage partner expertise, and participate in offerings with high-quality private growth companies. Such an approach also provides them more negotiating power related to financing terms and business direction.
Understanding Angel Investment Term Sheets
A critical legal document in the realm of angel investing is the term sheet, which acts as a precursor to funding contracts. This non-binding document functions as a letter of intent, outlining the proposed terms and conditions of the investment. It provides both parties with an opportunity to review and negotiate the terms before they are incorporated into a legally binding contract.
Key Provisions of an Angel Investment Term Sheet
An angel term sheet typically comprises of five key provisions that startup founders should be aware of:
- Investment Structure: This provision details the type of securities the angel investor will invest in. The most common types include common shares, convertible preferred shares, or convertible debt.
- Key Economic Terms: This provision quantifies the preferred return of the investment and any accruing earnings on the investment.
- Board Structure and Reporting: This provision outlines the angel investor’s role on the startup’s board of directors and the required reporting procedures.
- Corporate Governance and Shareholder Agreements: This provision includes details about the shareholder agreement among the founder group and the new investors.
- Due Diligence: This provision defines the timeline and process from the date of signing the term sheet to the closing date, as well as the conditions for closing.
Sample Template of an Angel Term Sheet
For a sample template of an angel term sheet, you can refer to the article. This sample can serve as a guideline when drafting an angel investment term sheet, helping you understand the layout and content of such documents.
The Process of Angel Investment
The process of angel investment typically involves five steps:
- Connect: Angel investors usually connect with startups via referrals, introductions, or startup accelerators.
- Pitch: After a connection is established, investors invite startups for a funding pitch, where verbal negotiations occur.
- Term Sheet: Following successful negotiations, the investors present a term sheet, outlining the actual terms that will be included in the final contract.
- Due Diligence: After agreeing on the basic terms, investors conduct a thorough check on all documents authenticating the startup’s operations.
- Final Contract & Fund Transfer: After all verifications, the final legal contract is signed, and funds are transferred.
Angel Investment Structures
There are a variety of structures that facilitate group investing, such as Limited Partnerships and Capital Pool Companies. Each of these structures has its own benefits and drawbacks, which are important to consider when choosing the right structure for your startup.
Limited partnerships allow angel investors to pool their resources, share risks, and leverage funds. By forming a limited partnership between a general partner, who is liable to all creditors of the business, and limited partners, whose liability is limited to the capital contributed to the partnership, investors can participate in larger deals than they could individually.
However, limited partners are not allowed to participate in the management or operations of the business, or they risk losing their limited liability status. Therefore, if you prefer your investors to be actively involved in your startup, this may not be the best structure for you.
Capital Pool Companies (CPC)
The Capital Pool Company (CPC) program, a product of TSX Venture Exchange, offers an alternative route to the traditional Initial Public Offering (IPO) for taking a company public. By forming a Capital Pool Company, seasoned directors can list it on the TSX Venture Exchange, raise a pool of capital, and use the funds to identify and evaluate potential acquisitions.
While the CPC program has its advantages, such as allowing entrepreneurs to leverage private dollars with public ones and reducing the complexities of VC term sheets and structures, it may not be the ideal structure for every company. Being a public company can be onerous on management and financial resources, and creating a CPC is not a liquidity event for founders or seed investors.
Angel investing in Canada involves several legalities, contracts, terms, and agreements that startups must understand before engaging with angel investors. Whether it’s understanding the concept of angel investment, learning about term sheets, or exploring different investment structures, each aspect plays a crucial role in securing the right amount of funds from suitable sources. With this comprehensive guide, you are now equipped with the necessary knowledge to navigate the complex world of angel investing. Happy fundraising!