Considerations for Angel Investors
My last post led to me getting a phone call from one of the best Angels I know on the London scene at the moment making some very important points.
I promised that I would write a blog about the points that came out of the conversation.
1. The importance of tax considerations. One of the big drawbacks with using loan instruments (such as convertible notes) is that it does not attract EIS relief. EIS is a very big deal for investors and given the likelihood of failure, for a very good reason. And of course with tax increases, the potential upside EIS very attractive.
2. From a security point of view, convertible loan notes only make sense if the underlying business you are investing in has assets. For example, investing in a company in the digital space will mean that upon a liquidation event, you will probably not receive any proceeds from a disposal even though you have a ‘loan’.
3. A conversion formula only makes sense if the conversion ‘event’ is in the short term (within 18 months). The example given was the following
An angel investors puts £100,000 into a pure start up in the digital space. The investment is made at a 30% discount to the next liquidity event convertible loan note formula. At this stage, there is nothing but a business plan. No revenues to speak of etc. The business quickly grows and does not require any more funding.
The business is then sold after five years for £5m. The investor then receives the £100,000 note back along with 30% extra. There is no conversion to take place as the shares are all being bought. A 30% return on a very high risk investment when there was nothing to back seems very low. It will grate even more when the founder walks away with £4.9m! You would agree that this does not seem like a fair split of the risks and reward.
My colleague also uses an interesting cap and collar mechanism. This mechanism ensures that both the company and the investor are protected on the downside and the upside.
