Friends, family and angels: Lend me your cash

By Kim Covert January 18, 201718 January 2017

Friends, family and angels: Lend me your cash

 

Long before many startup companies do their dances with venture capitalist dragons, they have to have smaller, important conversations with angels – friends, family members and the kind of people who make a business of handing out micro-loans (all things being relative) based on faith.

“An angel investor or an angel round or a seed round tends to be early in a company’s life-cycle, tends to be a pre-revenue stage, sometimes even pre-proof-of-concept,” says Michael Reid of McMillan LLP in Vancouver. He’ll be one of two presenters, along with Robert Cowan of McInnes Cooper in Halifax, for next February’s Skilled Lawyer Series webinar Business Finance for Lawyers I: Raising Seed Capital for a Startup.

“An angel investor is usually someone who’s making an investment on a lot of faith. It’s as much about investing in the individual and the idea as it is about investing in the actual business.”

Ponying up money based on pure belief is not for the faint of heart, and a lot of people will turn down the opportunity to crack their nest egg for a dream that may or may not come true. One of the original inventors of the game Trivial Pursuit was a journalist with The Canadian Press and even into the early aughts there were people at the national wire service kicking themselves for failing to dig into their pockets during what Reid calls the “friend-and-family round,” that all-important first round of fundraising, when companies don’t necessarily need a lot of money, but the wheel does need some grease to start moving.

Bank financing is the most traditional way of raising seed capital, but Reid says very few people start there any more – it’s more generally friends, family, business associates and external angel investors. Word of mouth and personal relationships are key at this level.

An online crowdfunding site like Kickstarter functions either as a donations platform or a pre-sale platform, says Reid, where you’re dealing with customers or donors rather than investors who expect to see an actual return on the investment. A new trend, he says, is equity crowdfunding, with some securities commissions starting to allow startups to raise equity through a crowdfunding platform.

“They’re very regulated so that you can’t just go on to Kickstarter and say that for your $100 contribution I’ll give you one share, that wouldn’t be allowed,” says Reid, noting that there is at least one equity crowdfunding operation in Canada, running out of Vancouver, that functions basically as an agent or a broker doing various levels of funding at once.

“(They can do) a typical offering memorandum for a public raise for a private company and they can also have either as part of that or separately an equity crowdfunding where you may be able to make an investment at the $500 level,” which helps attract people who like the idea but don’t have bags of cash sitting around to invest.

The model is still being crafted, but it works out to the benefit of both the investor and the startup, allowing the startup to market its product to the public, and, by virtue of making sure there’s a certain amount of diligence being done, protects even the micro-investor, who can be sure that it’s a sound investment.

Reid’s top tips for startups looking for seed investments are:

1. Make sure the investor is a good fit with the business. Remember that when the company is small the investor has a lot more impact than it would on a larger company from a governance perspective.

2. Make sure that the capital structure is set up in order to deal with what that investment means. “Oftentimes we’ve seen investors with some sort of convertible loan or whatnot and if the terms of conversion don’t really match with how the company’s structured, down the road you will potentially run into some difficulties.”

3. Make sure the paperwork is properly vetted on both sides. Strongly recommend that the investor have legal counsel. “It’s a very personal level of investment, the seed round, so ensuring that there is proper advice being given on both sides is really key.”

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