Becoming an Angel Investor

I want to be an angel investor.  At least I want to know how an angel investor thinks, given that I'll be pitching to a group of angel investors at the VT KnowledgeWorks Entrepreneurship Summit on April 7, 2010, and given the culture of entrepreneurship and angel investor funding developing in our region.

Many angel investment groups require their members to be accredited investors.

I started my research on accredited investors with the U.S. Securities and Exchange Commission:

An "accredited investor" is:

  • a bank, insurance company, registered investment company, business development company, or small business investment company;
  • an employee benefit plan, within the meaning of the Employee Retirement Income Security Act, if a bank, insurance company, or registered investment adviser makes the investment decisions, or if the plan has total assets in excess of $5 million;
  • a charitable organization, corporation or partnership with assets exceeding $5 million;
  • a director, executive officer, or general partner of the company selling the securities;
  • a business in which all the equity owners are accredited investors;
  • a natural person with a net worth of at least $1 million;
  • a natural person with income exceeding $200,000 in each of the two most recent years or joint income with a spouse exceeding $300,000 for those years and a reasonable expectation of the same income level in the current year; or
  • a trust with assets of at least $5 million, not formed to acquire the securities offered, and whose purchases are directed by a sophisticated person.

Expecting an online application similar to that for an Employer Identification Number (EIN), I looked for the button to click to view the online application.  No button.

Sometimes Google won't do, but one still needs a Google-like source.  When searching for answers about all things legal, I ask Ken Maready of Hutchison Law Group.

I asked, "How does one become an accredited investor? How does a company founder know he/she is talking with one?"

Because he is, as I term him, an entrepreneur's entrepreneur, Ken replied right away:

Although the term "accredited investor" makes it sound like there's some kind of registration process or certification with some third party, it's really much more simple than that – they just have to meet one of the tests below, and there's no filing or other process for them to become "accredited."

The most common accredited investors you'd be speaking with (outside of venture funds) would be individuals who meet either the net worth test ($1,000,000) or the annual income test ($200,000 per year – or $300,00 per year combined with spouse – for the last 2 years with an expectation of earning that again this year).

Net worth of a $1 million or $200K per year, eh? Not for this start-up's founder.  Not yet.

Especially given this caution from Tracy Wilkins, quoted in the Blue Ridge Business Journal:

"A lot of us are entrepreneurs who have made it ourselves and love the game, like to help and we love building companies," said Tracy Wilkins, an angel investor and president of TechLab, a medical diagnostics firm in Blacksburg. "Angel investing is very hard to make money out of, to be honest with you. Unless you can afford to lose it, you shouldn't do it. It's gambling."

Good to know a little more about with whom I may be dealing, though. Thanks, Ken.

A post of possible interest:
Advice to Start-ups Seeking Outside Investment

Where I Decided My Future
Who's in FRONT? Mike Pace

Comments

  1. I’ve often wondered about this. The word “angel investor” has almost become cliche – but I never really understood the dynamics of criteria used to determine that level.

    This is excellent information for all those adventurists in this new economy – the age of working a job may be dying. The age of building a business is here.

  2. Very nicely put – “The age of building a business is here.”

    Angel investing is a complex topic. More to come and I wrote about the subject on my corporate blog as well:

    http://annegilesclelland.typepad.com/blog/2010/03/talking-about-money.html

    Thank you for your comment, Christina!

  3. The reason that most angel groups require their members to be Accredited Investors is for the sake of the company, not the group itself. Here’s why:

    The SEC was set up in the aftermath of the Great Depression to protect people from being scammed with wild and crazy schemes floating their shares on the stock market and promising the moon. The result was a requirement that anyone selling equity (shares of a company) had to register with the Securities and Exchange Commission, and file a whole lot of detailed paperwork on the actual historic earnings of the company, the risk factors, background on the company management and owners, etc. etc. etc. That’s what being a ‘public company’ is all about, and why your widowed Aunt Martha and your simpleton cousin Ferdinand are able to call up their stock broker and buy two shares of Google, for example.

    BUT…the SEC realized that there were certain times when all that filing and paperwork wasn’t necessarily required, so they established certain exemptions to the registration requirements. The exemptions are detailed, and cover several different categories (you can sell stock in Handshake 2.0 to Goldman Sachs, for example, or Kleiner Perkins), but the exemption that will typically be most appropriate for most entrepreneurs, as Ken pointed out, is the asset/income test for individuals. The thinking is that someone who has that kind of money in the bank and/or continuous earning power, should be able to absorb the loss of the entire investment in your startup company if things go bad. One of the other things about being an Accredited Investor is that you need to have business experience, so you can make a good case that you’re not just throwing darts at a dartboard, or being swayed by Anne’s good looks, but that you really have made a considered decision to invest on the merits. (The test for ‘knowledgeable investor’ is a bit more nebulous than the hard asset/income numbers, but get to the same point.)

    SOOO…the bottom line here is that a company such as yours is exempt from all the public registration and filings when you sell your equity, but ONLY if everyone to whom you’re selling falls under one of the specific exemptions laid out by the SEC. What happens, I hear you ask, if you fudge a little and sell to people who aren’t accredited? Well, at some point in the future, when things get into trouble, they can turn around and accuse you of taking advantage of their poor, innocent, naivete, causing them to lose their hearth and home. And if a court upholds that claim, then not just THEIR purchase, but the entire ROUND in which they purchased equity, can be unwound, with you having to give all the money back, with penalties. This is NOT something you want to do! And it’s therefore why you, as the entrepreneur, want to make sure that you ONLY sell equity to Accredited Investors. It is for THAT reason, to reassure you about taking their money, that angel groups require their members to meet those qualifications.

    All that said, the burden for ascertaining their investor status is, and remains on, the company. So part of the closing paperwork in every deal in which I’ve invested as an angel is what’s called the Investor Questionnaire, often a six or seven page document wherein I tell the company exactly WHY selling to me is exempted from the SEC filing regs. This is something you keep with your closing documents, so that if things ever hit the fan, and I accuse you of taking advantage of me, you can whip out my signature and say “But David TOLD me that…and I relied on his representations.”

  4. Thank you !
    Hook me nks,haup !
    All right ?
    T

  5. I found this definition from Entrepreneur helpful:

    http://www.entrepreneur.com/encyclopedia/term/82114.html

    Here’s the opening:

    “Originally a term used to describe investors in Broadway shows, “angel” now refers to anyone who invests his or her money in an entrepreneurial company (unlike institutional venture capitalists, who invest other people’s money). Angel investing has soared in recent years as a growing number of individuals seek better returns on their money than they can get from traditional investment vehicles. Contrary to popular belief, most angels are not millionaires. Typically, they earn between $60,000 and $100,000 a year. Which means there are likely to be plenty of them right in your own backyard…”

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