Angel Investing A Year in Review
A p u b l i c at i o n o f A n g e l C a p i ta l G r o u p
Funding Our Tomorrow
angels
of the
year What is Angel Investing? P.09
Trendspotting P.12
"Betting on stocks is like betting on a horse race at the end of a race. If you want great opportunities, you should be looking at investing early in the next Facebook while they are starting up." — S t e p h a n Pat e r n o t
Private Equity Just Went Public P.16
Incentives for Angel Investors P.22
move the needle
W
e talk a lot here at the Angel Capital Group about moving the needle, by which we mean doing something every day that makes a difference. Over the last five years, we’ve managed to bring together a group of incredibly passionate people who set out to move the needle through business and investment. Every day. I want to tell you our story. I founded the Angel Capital Group in January of 2007. Up to that point, I had been occupationally split between both of the worlds we serve now: I was both an investor and an entrepreneur. By 2007, I had started three small companies, but my “day job” was as a stockbroker. I loved designing portfolio strategies, and it was through the pursuit of the optimal diversification model that I entered private equity. I had heard, from the traditional stockbroker’s perspective, that private equity was the wild west of finance—cowboys and all. But it seemed clear to me that private equity was the best way to diversify my clients’ public portfolios because the private markets reacted opposite to the public markets in most ways (hence diversification). Then there were the potential returns: private equity made the public market look like amateur hour. Which begged the question, How do I get my clients into private equity? The options were not encouraging:
Option 1: Venture Capital funds.
Most of the funds with good track records had minimum investments of $1,000,000, focused on one industry segment and hoped to be able to return your money in 10 years or so (maybe). But most of my clients didn’t have the net worth to put that kind of money into one fund and one industry wasn’t diversified enough for me to feel comfortable recommending the investment to a client. And who would want to tie up their money for that long? I began to see what people were talking about when they said (and say) Venture Capital is “broken.” Option 2: Invest as an individual.
I hadn’t heard much about Angel investors, and it’s tough to find these loners out on the range. I did find good information about Angel groups through the Angel Capital Association. Back then, most Angel groups seemed to operate as not-forprofit funded by local economic development entities that charged small membership fees (usually about $1,000) and were focused mainly on funding local companies for job creation. Entrepreneurs would present to these groups or deals would be shopped to the members with expertise in that particular area. I was left with a lot of questions and felt this model fell short in a couple of ways. For example:
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»» How was I supposed to build a diversified portfolio if I only looked at deals in a specific area? »» How many deals would we do in a year? »» How was I supposed to know if it was a good deal? »» How are these investments made? »» What if I want to invest outside my area of expertise? »» How much money were they expecting me to invest? »» How would I manage all the accounting and legal work of doing this type of investing? I set out to create a service company that would provide the answers. Our response to investors looking at Angel investing was: »» Do as many deals as you can – at least 20 in as many different industries as possible. Diversify, diversify, diversify. »» Leverage the knowledge and experience of the investors around you by being part of a group. At the end of the day, any investment we make is a “good deal” because we, personally, believe in it. No one can pick winners every time, so we spread our bets and use our network members to make those bets educated across many industries. »» ACG handles all the deal structuring so you don’t have to compete with other members on deal terms or incur the legal fees of structuring the investments. »» We operate under a fair play model. All members review the same deals, and every member gets to participate in any deal they want. »» No one is expected to invest any minimum amount of money. In fact, we don’t charge anything until you find a company you want to invest in. There are no individual minimums, so you can build the portfolio you want. »» Post-funding portfolio maintenance is our service commitment to you. Oh, and we would be very much for-profit. Let’s be honest: not-for-profit isn’t exactly my language, and I wanted to make sure our team was 100% committed to our investors making money because that meant we made money. We call that a win-win. At the end of the day, we all have a lot of choices about how we invest our time and money, and I want each of our members to know how grateful we are you have chosen to invest with us over the years. We think of ourselves as the catalysts, but it’s you who truly move the needle. So here’s to funding the future. We think it's looking bright. Kind Regards, Rachael Qualls F o u n d e r & CEO
For More Information visit our website
theangelcapitalgroup.com
Contents
"Betting on stocks is like betting on a horse race at the end of a race. If you want great opportunities, you should be looking at investing early in the next Facebook while they are starting up." — St e p h a n P a t e r n ot
10 left
on the cover Sam & Jeff McCamy on what to do after a successful exit.
05 04 Why Did You Become an Angel Investor? Local Chapter Founders on what led them to Angel investing.
05 Angels of the Year Sam and Jeff McCamy talk about the transition from hands-on business to portfolio management.
08 Stages of Capital Find out why some doors open, instead of close, when asking for money.
09 Angel Investing Primer The difference between Angel investing and its private equity brethren is more than just early- vs. later-stage investment.
12 Trend Spotting Our market projections and insights from working on the front lines of innovation.
15 New Leadership Three network directors bring long histories of entrepreneurial and investment experience to ACG.
16 Crowdfunding
New legislation in Washington D.C. could change everything about the way Americans invest their money.
above
trend spotting The newest seed-stage startups that have our attention.
21 Kansas City
This unassuming city has recently gained a reputation as a hot bed for entrepreneurial investment, high culture and the innovations of the future.
22 Tax Credits
28 Preferred Deal Structures Legal structures have a tremendous impact on converting high-risk to high-return. Attorney Philip N. Krause weighs in on investor protections in today's markets.
Government Incentives for Angel Investors.
35 More About Membership
25 Our Portfolio Companies
Learn more about investment opportunities and how to join Angel Capital Group.
ACG's stakes in healthcare, mobile, storage, and more.
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thoughts from our founding members
Q:
why
did you
Angel
become an
Investor
"To help others achieve their goals while simultaneously diversifying my portfolio and learning from other investors along the way." —Dr. J. Sheats
"...for the profits, to diversify my investments and for the opportunity to invest in businesses at the beginning."
—Steven L. Revare
"I enjoy seeing new companies with fresh ideas come to the market, and I plan to make some money at the same time.
"First, Angel Capital came to me through a close friend and successful businessman that added validity. Second, there is no such vehicle for investing in Jackson, MS that was open to the small investor. Sure there are deals, but the opportunities were offered within cliques requiring substantial investment most of the time. And third, I was impressed with [ACG's] presentation, knowledge, and professionalism. "
—joe ivey
—Andrew E. Gay
—jim mitchell
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"I view angel investing as putting money into the most vibrant and important part of our economy. I also see a need for education among angels outside of larger markets, and ACG does an excellent job of doing that here in Kansas City."
a n g e l c a p i ta l g r o u p
feature story
angels
ofthe year What happens when the family business is wildly successful? We spoke with Knoxville chapter founders Jeff and Sam McCamy about their big exit and the transition from managing a business to managing investments — and how Angel investing fits into their overall financial plans.
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angels of the year
Tales from the Front Lines: B rothers
Sam & Jeff McCamy What is it like to take a family business to exit and suddenly face the question you always dreamed of facing: Where do I put all this money? We asked two of the founders of our Knoxville chapter, Sam and Jeff McCamy, to find out.
“If somebody knows you’ve got any money, they’re after you.” —Sam McCamy
That, in a nutshell, is what happens after a successful exit. And don’t get him wrong: it’s a blessing, not a curse. But it’s something a lot of successful entrepreneurs don’t anticipate when they finally exit and liquidate their life’s work into cold, hard cash. When the world finds out you have it, the world comes knocking. Sam and Jeff McCamy were third generation owners of Roden Electric Supply, an electrical distributor in Knoxville, TN. They supplied lightbulbs and electrical components and built a reputation in the industry that proved to be very valuable to some bigger fish in the sea. Both were attracted to seed- and early-stage investing because of their own depth of experience in growing and operating a business. As with many business owners after exit, it was difficult for Sam and Jeff to come to terms with the idea of handing their hard-earned money over to a wealth manager and going “hands off ” for the rest of their lives. “I wasn’t ready to quit working,” said Sam. “I retired on a Friday and tore a house down to develop a property the next Monday.” Real estate was the first financial destination for the McCamys, who still have a contracting business. But in 2007, real estate proved to be a tu-
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multuous ride, and the other obvious destinations for capital investment weren’t doing much better. Asked what he’d do differently in the first six months after selling the family business, Sam said, “I’d probably just have gone a lot slower.” They started looking for investing alternatives that would satisfy a few basic requirements: it needed to be hands-on (not that they wanted to manage a business, but they at least wanted a more direct connection to the vehicles in which they were investing); it needed to be aspirational, fulfilling their desire to be a part of major growth; and it needed to be fun. As Jeff put it: “I think you need somewhere around 10% of your money in high-risk, highreturn investments. It’s like gambling money, but you can really win.” Sam’s third requirement—that some investments need to be fun —is a fine line with any investment class. Having the right perspective is crucial to enjoying the potential for high returns. “The way it was described to me when I got into it was, ’80% of these companies might fail, so we’re going for 10X returns on the ones that don’t.’ So I just thought, ‘I’d better spread my chips across the table.’” In practice, the Knoxville chapter has done better so far, but Jeff and Sam both advocate cautious optimism with Angel investments. Ironically, though, it was losses in conventional investment vehicles like stocks and real estate that led them to
Angel investing in the first place. “I invested in real estate and it crashed. I invested in the stock market and it crashed,” Jeff said. Jeff and Sam both prefer to have at least a portion of their portfolios invested in companies they can personally scrutinize, meet and keep up with. They also believe the potential returns justify the “risk” associated with seed- and early-stage investments. Once they knew the type of investments they were looking for, the question became how to go about it. In the seed- and early-stage investing world, there’s no shortage of people willing to accept funding, but finding serious, organized entrepreneurs with solid business plans can be difficult and costly for the solo Angel. Jeff recalled the informality of some of the first opportunities they looked at, opportunities they came across as by-products of their personal network of family, friends, and acquaintances. “It’s a much more casual first step that way,” he stated. “ When they go through the Angel Capital Group, they’ve already done the casual pitch they give to family and friends, and the ACG team gathers a lot more information, so when they present to our group we’ve already seen the 360 degree evaluation.” Sam agreed, “Outside of the group, it’s just somebody coming to your house and showing you something.” Jeff and Sam both knew their ac-
cess to deals as individuals would be limited, and they were searching for opportunities outside their own professional spheres. Additionally, they recognized the high cost of legal and accounting support and due diligence “going it alone”. With most of their professional experience in distribution, the prospect of limiting an Angel portfolio to businesses in their field of expertise wasn’t so exciting. But they didn’t want to make investment decisions blindly. When they were invited to one of Angel Capital Group’s presentations on Angel investing through local networks, they were intrigued enough to attend. The idea of gathering other investors interested in seed- and earlystage investments and sourcing deals through a national group that offered due diligence and legal/accounting efficiencies sounded appealing. Jeff and Sam decided to become founding members of a new Knoxville chapter. The group has since grown, a fact that improves the insights and experience for every individual member. Sam explained: “ We used to say in meetings, ‘ You didn’t tell me I was going to have to be a smart guy. But every time we [the Knoxville chapter] look at a deal, someone in the room has had some kind of experience with it. There’s always a smart guy about something. It may not be me, but someone in the room can help the rest of us.” Jeff added: “One thing to know is that you have to leave your ego at the door to get the most out of the group dynamic, and I think that can be tough for some people.” Control of the conversation may need to be shared, but Jeff and Sam both feel the value of more experience, expertise, and perspectives help make an often casual, informal investment vehicle more structured, navigable, and safer than it otherwise would be. “There’s definitely a process this way”, Jeff said. The group dynamic also cuts costs and in many cases speeds the over-
cess early on.” Jeff reiterated the long term nature of Angel investing: “It takes a long time, and you have to be prepared for that.”
Since 2008, the McCamys have invested in over 13 companies bringing new jobs and innovation to local and national economies, ranging from feeding devices for premature infants to the next generation in smart city design.
Of course, Angel investing isn’t the only game they play. To Sam, with a contracting business, conventional stock and real estate holdings, partownership of a hotel in the Florida Keys, and some other investments, Angel investing is just a part of the big picture. But it scratches an itch. “I wasn’t ready to just hand my money over to a wealth manager,” Sam said. "If you’re used to running a business or doing something like that, it’s just hard to let someone else do it for you.” Jeff's portfolio is similarly diversified, including a recent investment opening the Knoxville, TN location of Barre3, an innovative fitness technique with nearly 30 locations. With the right perspective, Sam said, “it’s a piece of the portfolio that’s just kind of fun.” And it connects him with new relationships and new investment opportunities in Knoxville and throughout the Angel Capital Group network.
So what does it mean to be an
all process. “There’s a process that’s more professional than somebody just coming to my house and asking for my money,” Sam said. “There’s a deal screening and due diligence process with Angel Capital Group, and legal resources you just can’t get on your own without spending a ton of money.” For the Knoxville chapter, that process has paid off so far: “Out of 13 deals, we’ve only had one go bad —knock on wood. It’s all about the exits, so there’s more road to cover, but we’ve had good suc-
Angel of the Year? To us at the Angel Capital Group, it’s individuals that maintain an enthusiasm for seedand early-stage investments, understand both the idealism of funding innovation and the systemic benefits of seeking high growth, and demonstrate the leadership and vision of “leaving the ego at the door” to be part of a group dynamic. We believe Angel investing opportunities are some of the best options available for seasoned investors today, but they need to be formal, structured, and organized in order to maximize returns and limit risk. Jeff and Sam McCamy have been indescribably helpful to us as we’ve pursued these goals in Knoxville and our other chapter locations, and it is for this that we’re happy to name them our 2012 Angels of the Year.
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Stages OF Capital
It is often believed that if you have a great innovation, people are lining up at the door to write seven figure checks, but that's just not the case. Capital comes in stages, so know where you fit and why some doors open instead of close for you when asking for money.
Source: PricewaterhouseCoopers/National Venture Capital Association MoneyTree™ Report, Data: Thomson Reuters.
Company Stage Ideas; pre-revenue and pre-proof-of-concept
Seed Funding
Use of Funds To build a prototype and
get customer feedback
Valuations $100,000 - $1,000,000 Resources Accelerators, Incubators,
Less than $50,000
Seed Funds (Ycombinator, Techstars, etc.)
Annual Deals 500,000+ Company Stage Proven concept with little or no revenues
Angel Funding
Use of Funds Monetizing the product or
service, i.e. Sales and marketing
Valuations $1,000,000 - $3,000,000 Resources Angels can either be individu-
$100,000 - $500,000
als, organized groups, or participate in small Angel funds of about $5M or less.
Annual Deals 30,000+
Early Stage Venture Funding
Company Stage $250,000 to $1M in
revenues
Use of Funds Growth Valuations $3MM - $10MM Resources Venture funds range in size
$1M - $5M
Later Stage Venture Funding $10M +
from $10MM - $50MM at this stage
Annual Deals 3,051*CB Insights
Company Stage $10M+ Revenues and established market share Use of Funds Strategic Acquisition,
Market Expansion, or recapitalization
Valuations Vary greatly Resources National Venture Capital
Association
Annual Deals 679*
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a n g e l c a p i ta l g r o u p
venture capital
w h at i s a n a n g e l i n v e s t o r ?
angel investing primer
ck stoanges h exc
pri vat e equ ity
Angel investing
What makes Angel investing unique in capital markets?
Popular culture
tends to compartmentalize investing into two worlds:
public stock exchanges and the shadow world of hedge funds, venture capital firms, and ultra-high net worth individuals. Oftentimes there is a basic misunderstanding of how ideas move from garages to high rises, particularly when it comes to the role of capital in the business lifecycle and the motivations of those allocating the funds. Angel investors are frequently lumped into the same world as better known private equity players like the aforementioned hedge funds, venture capital firms, and mega-wealthy, but, in both character and practice, Angels belong in a class of their own. The Angel mentality differs from other private equity investors in two key ways: first, Angels are playing with their own capital. They have skin in the game. Where VCs, hedge funds, and other private equity players raise funds from other investors and take management fees and percentages on performance, Angel Investors typically seek to deploy their own capital direct to the source. Second, Angels are frequently seasoned entrepreneurs — they have been there and done that. Capital, therefore, is not the only asset Angels bring to the table; they also offer wisdom and experience and can lend a guiding hand to the businesses they invest in.
Contrary to popular belief, the most successful Angel investors are not active in the companies they fund. These investors understand that they have to put math in their favor to be successful – and that means doing a lot of deals. The most successful Angels, like Ron Conway or Chris Dixon, have invested in over 200 companies between the two of them. However, even though good Angels stay out of the kitchen, they often add a lot of value by bringing longestablished networks of business relationships to the table that can be leveraged for the businesses they invest in, creating opportunities and
benefits that otherwise might not be available. It is important to note that it is up to the entrepreneur to leverage this network instead of waiting around for the Angel to offer up the help. At the end of the day, the Angel Investor’s biggest thrill may best be described as one part ROI and one part changing the world. Playing an important role on the front lines of innovation is a significant motivator for Angel investors deploying capital, so the typical business that receives Angel funding can expect a uniquely committed capital partner in the sensitive early stages of growth.
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Angel Investing Primer
Who are angels?
What do they invest in?
Source: http://www.angelcapitalassociation.org/data/Documents/Resources/AngelGroupResarch/1d%20-%20Resources%20-%20Research/6%20RSCH_-_ACEF_-_Returns_to_Angel_Investor_in_Groups.pdf
Angel investing has historically been an isolated world: wealthy entrepreneurs making investments in new startups whenever enticing opportunities appear on their radar. But technology and market incentives are leading Angels to organize into groups or networks that offer advantages and efficiencies, sometimes even for the maverick, go-it-alone types. The high cost of legal services, need for robust deal flow, access to information and insights, and network benefits are but a few of the many factors bringing America’s elite class of investors together in increasingly powerful Angel investment groups. legal expenses
Deal structures vary widely depending on the nature of the startup and the industry in which it operates.
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Angel investments frequently take place before a business has revenue, and sometimes before a business even exists. In fact, for a certain subset of Angel investors, the thrill of the hunt is all about identifying truly game-changing ideas and offering the funding and guidance necessary to take them to market. Thus, the legal structures associated with Angel investing can be complicated, mainly because the value of a certain business, idea, or product at such early stages is highly subjective and because both parties in the funding process need to be protected from a multitude of circumstantial variables that might inhibit the business’s growth and determine how profits are shared thereafter. Additionally, there are two sides to every coin: sometimes an Angel investor’s enthusiasm and experience are of
immense value to a startup; other times, entrepreneurs need the freedom to be quick and agile without having to play politics with a capital source. Finally, each deal is unique; there is no one-size-fits-all legal structure for this kind of investment. For both parties, achieving the proper deal structure is worth spending time and money to do correctly. Legal fees for structuring an Angel deal can range from $15,000 - $50,000. If you are investing $100,000$200,000, you can see how material legal fees become. deal flow
With most Angels making around ten investments at a time, robust deal flow becomes essential for good odds. The larger the sample size, the more discriminating Angels can be when placing bets. But the typi-
cal Angel investor can only screen as many opportunities as their personal network and sphere of influence place on their radar; you can only invest in deals you know about. Angel groups or networks often have their own marketing teams and local or regional reputations that attract entrepreneurs. Some even have staff that screen applicants on behalf of Angel investors. Whatever services these Angel networks offer, though, the net result is more deal flow and better odds for the individual Angel.
arrangement, inhibiting one’s ability to see the forest and not the trees. Angel networks that hold weekly or monthly gatherings bring successful individuals from a range of fields together to discuss ideas and share perspectives, and while these events tend to be highly social in nature, they also facilitate an exchange of ideas among a highly qualified group of people. This allows the isolated investor to hone their visionary skills and see beyond the realm of their own experience.
Market Information & Insights
Just the way that the solitary Angel’s investment opportunities are limited by the number of deals existent in their personal network, the postfunding resources available to the funded business are limited when an Angel “goes it alone”. By contrast, pooling resources with a group of Angels allows each individual investor to enjoy the others’ relationships, which in turn just puts more resources at the disposal of the funded business and
This is the iron-sharpens-iron adage in real life. Most Angel investors are highly independent, self-made individuals. They are experts at creating something from nothing, a skill that can be as much of a curse as it is a blessing. While the intensive, business-centric focus required to launch and sustain an idea or startup is advantageous to the entrepreneur, it can be limiting on the capital side of the
Network Benefits
increases the likelihood of success.
By nature,
Angel Investing attracts a unique type of investor and inspires a unique style of funding. Unlike other private equity vehicles, Angel investing is intimate and personal by design; locality, collaboration, and mutual commitment are essential ingredients for any deal, both for Angels and the businesses they fund. Technology may be playing a role in expanding horizons for people everywhere, but new social tools are also making it easier for local individuals with mutual interests to connect, invest, and build. Angel investing may be private equity just like venture capital and hedge funds, but by character and practice it’s a world away. For today’s visionary entrepreneurs with the ideas, inventions, and services that will change our tomorrow, Angels are right there on the front lines of innovation, too. Funding a better tomorrow for us all: it’s what Angel investing is all about.
top 10 angel investors 2010 rank
investor
no. of angel investMENTS
no. of employees
funding received* best financial most ($ millions) performance** influential***
most diverse portfolio****
Investment focus
1
Chris Dixon
23
3,283
1071.77
1
11
1
B2B internet services, consumer internet
2
Ron Conway
190
29,703
3407.01
2
1
12
consumer internet, mobile
3
Reid Hoffman
49
69,796
2270.94
4
3
24
consumer internet, social networking, gaming
4
Esther Dyson
60
5,357
480.518
3
16
25
consumer internet, social networking, space exploration
5
Peter Thiel
26
69,499
1577.35
8
2
9
consumer internet, mobile, B2B internet services
6
Marc Andreessen
53
3,835
1157.6
6
6
20
cloud computing, virtualization, SaaS, computer software
7
Jeff Bezos
18
21,028
482.89
5
12
16
online marketplaces, space exploration
8
Chris Sacca
31
593
296.385
16
9
6
B2B internet services, consumer internet
9
Mike Maples
39
3,377
522.62
13
13
8
consumer internet, mobile, gaming, retail
10
Andy Bechtolsheim
49
31,184
954.8
12
8
19
B2B internet services
10
Paul Graham
129
606
84.443
7
14
21
infrastructure, virtualization, networking
Figures are total for all companies in the portfolio. **Annual growth of investments, companies operating at valuations above $100 million, and the sale of any companies for over $50 million. ***Co-investment connections reveal how many angels they have worked with, uniqueness of co-investments, and critical bridges between angel groups. ****Range of industries and countries in the angel’s portfolio.
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t h e l at e s t m a r k e t fa d s
Trend Spotting
We work diligently to maintain our reputation as a refuge and resource for entrepreneurs across America. And while we really are good people, this work isn’t just nicety; deal flow and deal screening are often the two most cited reasons Angel investors give for joining the Angel Capital Group. It’s a symbiosis of capitalism: entrepreneurs come to us because of our amazing chapters and members; those members get incredible value when they see more deals than they would as lone wolves trying to place bets in the open market. All this we expected, and facilitating that positive interaction between entrepreneurs and Angel investors is why we began in the first place. What we didn’t expect was how much we’d be able to learn about the economy and where it is taking us by analyzing the types of ideas, technologies, and business plans being submitted everyday through our entrepreneurs’ portal. More than any other private equity investments, it’s the seedstage and early startups that show the orientation of the marketplace and provide promising guides for placing smart bets on the innovations of tomorrow. This year, we decided to piece together the insights and intuitions we’ve gained from exposure to over 300 applications, pitches, discussions, and fundings. Based on our deal flow and aggregate history, here’s where the action is:
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trend spotting
1
mobile.
What has always amazed us about the mobile market is how quickly breakthroughs in processing power, storage, wireless speeds, and user interfaces are seized upon by thriving app markets. There’s an army of exciting companies out there putting creative energy and incredible product-tomarket speeds on the table for investors that have a knack for picking the next big thing. From a high level standpoint, we see mobile banking, geolocation-based products (and the advertising opportunities geolocation will offer), and new pathways to search (Siri et al.) breaking down the barriers between users and their de-
Agriculture. Information is power in an industry providing the basics to the masses. And the more consumers learn about the way the food and products we use everyday are grown/processed/made, the more they’re demanding better. From today’s biggest agricultural corporations, we expect to see continued investment in innovations and inventions geared towards better margins and faster production. Think Monsanto and bioengineering. We don’t like to be pessimistic, but the demand for cleaner, healthier, more sustainable food and products all seems to be at the local level right now. And that local level is thriving: from community-centric food production concepts like The Plant in Chicago (a massive industrial factory turned into a CSA/farmer’s coop using
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vices. If there’s one question to ask a startup in this space, it’s, “How is your technology as vital to the average consumer as their favorite appendage?” Drilling down a bit, we’re seeing some small time players in the payment processing space (Square and others) leveraging mobile add-ons and apps to compete with the de facto corporate rulers of traditional payment processing. We’re also seeing increased interest in cost-cutting telemedicine/ healthcare applications. (A major offshoot of this would be the dataphiles pushing the “Digital Self ” —tracking, measuring, analyzing, and aggregating as much personal data as possible on a mobile device through bluetooth- and nearfield wireless-enabled devices like heart rate monitors, sleep monitors, random reporting applications, and more.)
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the latest hydroponic technologies to grow food indoors) to complete vertical farming technology companies selling turnkey urban “farmland”, there’s plenty of room to grow in agriculture today. And going back to the geolocation apps mentioned above, there are plenty of ag-meets-social companies looking to streamline and modernize the relationship between consumers and farmers.
Clean Tech. By now, most
ping out of R&D and into product-to-market soon.
of us have figured out that even though we can get our cars to run on corn, it doesn’t make sense to do so. That’s not stopping farmers from growing the subsidized crop with reckless abandon, but it’s certainly not where the ROI is going to be long term.
Hydrogen | It’s a little volatile and prone to bursting into flames, but that’s not stopping some very exciting startups. They’re discovering safe storage and transportation methodologies to circumvent the threat of daily Hindenbergs. If/ when they succeed, look out: it’s far easier to make hydrogen than it is to drill two miles deep in an ocean, let alone achieve stability and peace in the Middle East.
Solar | Like many leading energy technologies, the price for solar power is plummeting, the efficiency is increasing, and because of our thinning ozone, the sun is an ever more powerful source of energy waiting to be harnessed. OK, that last one’s a joke for everyone to argue about, but look for some well-funded solar technology companies to start step-
Wind | It’s no silver bullet, but better designs that are cheaper for the average homeowner to purchase and install could definitely provide some easing of demand on the grid and offer a domestic-sized ROI equation to encourage consumer adoption.
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trend spotting
4
Consumer Products.
Medical Devices. From genealogically treated can-
It may be 2012, but every year inventors and entrepreneurs find that a boatload of cash awaits the person who can solve a basic problem for a large group of people. Think Spanx (funded by Angel investors), Snuggies (kidding, but serious: Scott Boilen, who brought us the Snuggie, profited an estimated $200 million off the idea), and any one of the ridiculous but actually pretty helpful gadgets at Home Depot.
cers to minimally invasive laser treatments that cut the scalpel out of surgery, look for therapies and treatments that make some of the most common medical treatments less invasive and uncomfortable. Remember: it’s not just the comfort of the patient with these technologies; the less invasive a treatment is, the more it tends to reduce infections and complications for hospital and surgical groups, a major value proposition.
Consumer products don’t lead in technology, rarely offer broad solutions for humankind, and often have marketing tag lines like, “And it’s just $___”. But there is huge demand in the marketplace for any product that offers practical improvements in daily life. You may not make it the centerpiece of your portfolio, but if an inventor/entrepreneur comes along with a product idea that you think you just might actually buy, give it a second look!
On that note, look for a continued shift to disposable devices and small wares in the hospital settings. We’ve heard it said that a successful disposable white doctor’s coat would be as useful to a hospital as a state-ofthe-art laser system that revolutionized surgery. Some of the big winners in this space may be much more simple than we’d expect.
5
It’s a modern world, and we’re seeing proposals in our deal flow that are truly exciting in that “see the future” way that always tantalizes the Angel investor. But for every one of those, there are ten extremely simple ideas that build on the steady progression of innovation in our society today. These are often the best bets for Angels looking for something that offers an understandable roadmap from the idea phase to marketing and sales. And lastly, with so many ingenious entrepreneurs and inventors out there attacking so many opportunities head on, the name of the game is playing the odds: if you can look at 100 deals, do it. If you can look at 200, do that. Nothing gives a sense of the marketplace and what is and isn’t ready for the big time better than a large sample size. If you’re having trouble with that, give us a call. We have new applications coming in daily.
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a n g e l c a p i ta l g r o u p
w h o i s a n g e l ca p i t a l g r o u p ?
new leadership Eric dobson Chief Financial Analyst & Knoxville Director Eric Dobson joins Angel Capital Group as both Chief Financial Analyst and Director of the Knoxville, TN chapter. Eric was the founder of TrakLok, an ACG portfolio company providing cargo security and tracking devices and services across the globe. TrakLok was awarded the Pinnacle Innovator of the Year by the Innovation Valley Technology Council and Knoxville Chamber of Commerce and has raised over $4M from investors such as Piedmont Angel Group, Innova, and IMAF West. Eric has expertise in technology ventures, business case analysis, and marketing launches. In addition to TrakLok, he started Navigational Sciences, which has won several awards from the United States Departments of Energy and Homeland Security. As Chief Financial Analyst, Eric will play a critical role in helping ACG continue to raise the bar for services offered to both Angel investors and entrepreneurs.
BJ howard Nashville Director B.J. Howard is the founder and current President / CEO of Convergenz, LLC. He founded the company in September 2010 and continues to work with the CEO’s at many of the top performing companies in Middle Tennessee. Prior to his role with Convergenz, B.J. owned SDI Consulting, Inc., a corporate strategy consulting firm with a dedicated focus in the automotive segment. Much of his experience was gained through his career at Ford Motor Company where he held several positions, including the position of National Consulting Manager. In this role he designed, developed, and executed a formal process to evaluate underperforming businesses and develop strategies to return them to profitability. He received his B. A. degree in Economics from Rollins College in Winter Park, Florida and also studied Corporate Strategy and Leadership in the Harvard Business School Executive Education program.
Michelle desilva Midwest Director Michelle was formerly a Wealth Manager at Pegasus Capital Management. Prior to that, she was a Consultant at the Greater Kansas City Community Foundation. Earlier in her career, she was employed in Boston at Fidelity Investments in their management training program, and at Thomson Reuters in portfolio management information systems product management and design and sales consultation management. Michelle is currently Treasurer at the Truman Medical Center Charitable Foundation, a board member at MOCSA (Metropolitan Organization to Counter Sexual Assault), executive board member at Chatham Yacht Club, and is a former member of the board of directors at Starlight Theatre. Michelle is married to her husband, Peter, and has two girls. She enjoys windsurfing, tennis, the outdoors, and spending time with her family.
a y e a r i n r e v i e w : f u n d i n g o u r to m o r r o w
15
Crowdfunding Private equity just went public.
Crowdfunding is a new topic in the world of finance, so before we discuss the current legislative activity, it may help to have a quick recap of financial regulation in America. Don’t worry— we’ll only cover the relevant highlights. Today’s private equity market owes
much of its structure the stock market crash of 1929. Congress passed a series of bills after 1929 to try to protect the American people from fraudulent securities. The most important for our purposes are the Securities Acts of 1933 and 1934. We are paraphrasing, but it goes something like this: If you want to raise capital from the public, you must qualify and register on a public exchange, then adhere to strict regulatory practices. Most importantly, if a company doesn’t register with the
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a n g e l c a p i ta l g r o u p
SEC, it cannot advertise that it has securities for sale. This drastically altered how companies could access capital. If you can’t advertise, how are you supposed to sell your stock? Also, if you are already successful enough to go public, why would you want to go through all the expense of registering and the headaches of dealing with regulators? The fact is that the best companies don’t go public unless they need investor liquidity—an important thing to note for later. The government reasoned that most people didn’t have access to the infor-
mation needed to make good investment decisions, and therefore, needed to be protected through regulation. In addition, the thought was that if someone had enough money to be accredited, they 1) had more risk tolerance and 2) were probably more sophisticated with money. Adjusted for inflation, $1,000,000 in 1933 was the equivalent of $16,657,042.79 in 2010! It is the accredited investor exemption that gave birth to the modern day private equity market that now includes individuals ranging from Angel investors to venture capitalists. The term “Angel Investor” actually comes from Broadway, where the wealthy investors who would finance plays were called, “Angels.” The term became popular in 1997 when the first Angel investor network was started in California. Some believe that Angel investors were the catalyst for the incredible technology boom of the last 15 years
crowdfunding
—we couldn’t agree more. Because Angel investors were willing to invest earlier and take on more risk than traditional venture capital funds, more capital was accessible to start-up companies. In addition, traditional venture funds were set up to fund large companies with massive capital needs and typically only invested $10M or more. However, with the commerce platform of the Internet, companies no longer needed such large sums in order to gain momentum. Larry Page and Sergey Brin were turned down by every venture capital firm for their search engine idea because they didn’t need enough money. Then in August of 1988, Sun Microsystems co-founder Andy Bechtolsheim wrote a personal check for $100,000 to an entity that didn‘t exist yet: a company called Google Inc. Google and a number of other world-changing businesses and innovations, wouldn’t exist today without Angel investors. Today, there are over 258,000 active Angel investors in the US. Angels invested over $20.1 billion dollars in 2010, which is more than all venture capital funds combined (2010 Report from the Center for Venture Research at the University of New Hampshire). Angel investors are a crucial part of today’s entrepreneurial ecosystem. This is all well and good, except that there are more entrepreneurs, inventors, and startup businesses in need of capital than there are Angels to fund them. There are also millions of entrepreneurially minded citizens that deserve a chance to fund and receive the fruits of seed- and early-stage investments. Many market experts now say that finance regulations in America unnecessarily cut everyday Americans and a large number of startups out of private equity markets. And it looks as if Congress might agree. Right now, as this article is being written, congress has passed legislation that would bring private equity into the
public sphere once more. The space is currently referred to as crowdfunding. Of course, the power of raising funds using social tools like Facebook, Twitter, and others isn’t exactly new, but currently no funds can be raised by selling equity or securities. Instead companies use free products, tickets, or good ol’ emotional appeal. Here are just a few of the leaders in this space, with quick summaries of how it works for contributors: Kickstarter. If you haven’t been hit
up via Facebook by one of your friends for a book or blog project, business or product idea, charity, or even adop-
tion being funded through Kickstarter, we’ll just assume you haven’t turned a computer on this year. With Kickstarter, anyone can set up their idea or pitch, set a fundraising goal, and get out on the social networks to gather contributions. Pledgers can’t receive equity or any other kind of return on their investments, but they’re often rewarded with the eventual product itself, a thank you gift, or some other small trifle. Funds aren’t collected until the fundraising goal is met, so people tend to give more freely knowing they won’t potentially fund a dud right out of the gates.
If you want to raise capital and not have to register on a public exchange, then you must sell your securities to accredited investors. An accredited investor is any one of the following: »» 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 who has individual net worth, or joint net worth with
the person’s spouse, that exceeds $1 million at the time of the purchase, excluding the value of the primary residence of such person;
»» 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 in excess of $5 million, not formed to acquire the securities offered, whose purchases a sophisticated person makes.
a y e a r i n r e v i e w : f u n d i n g o u r to m o r r o w
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crowdfunding
Peerbackers. A little more entre-
preneurially focused than the causeoriented Kickstarter, Peerbackers gives entrepreneurs a place to raise unregulated cash in exchange for... hardly anything at all. Even if a startup could access private equity, it’d probably be a good idea to take some bucks here first if they could—most of the time, it’s just some kind of future promise, reward, or perk that entrepreneurs give back in exchange for the cold hard operating or investment capital they need. Profounder. Profounder is shut-
ting down, and the reason they give is a perfect illustration of the legislative effect of the Securities Acts of ’33 and ’34 on public access to private equity (taken from the Profounder.com website): We started ProFounder in August 2009 with the mission of ensuring that all entrepreneurs have access to the resources they need to succeed through the engagement of robust, supportive communities. We created a platform and set of tools that made the process of raising investment capital from friends, family and community more efficient, inexpensive, straightforward and legally compliant...Despite our progress, the current regulatory environment prevents us from pursuing the innovations we feel would be most valuable to our customers, and we’ve made the decision to shut down the company. So there you have it: without the sale of actual securities, crowdfunding is currently stuck in an idealistic but ultimately limited state. So what’s in the legislation currently being batted around in congress, and how could it change the world as we know it? Glad you asked. Here are some of the highlights:
»» Crowdfunding can only occur online »» Entrepreneurs can raise up to $1 Million per year through “approved” channels from any investor they want – not just accredited 18
a n g e l c a p i ta l g r o u p
»» Investors with incomes of less than $100K/year will be limited to 5 percent, or $5K, investments, while those who make over $100K/year will be limited at 10 percent, or $10K. Among other things, the bill requires crowdfunding sites to provide further consumer protection, such as providing educational materials which inform people of the risks inherent to the process. Another notable measure: the legislation does away with the 500-shareholder rule, which put a cap on the amount of shareholders a company was allowed before having to register with the SEC. Under the JOBS Act, companies now have a longer grace period before being required to report financial data, are able to sell up to $50 million in shares, and are now allowed as many as 1K shareholders before starting the process of going public. So, what does all this mean for the Angel investor and you? For starters, Angel investors will remain a critical class of private equity. Unlike the “crowd”, accredited Angels will be able to invest considerable sums of money. Unlike VCs and other private equity players, Angels will remain focused on very early- and seed-stage opportunities. Angel investors paired with the right network may soon find it easier to close funding rounds if the network has enough social networking prowess to enlist the newly eligible masses when it becomes necessary to do so. For today’s entrepreneurs, rising above all the online noise won’t just be a marketing problem anymore; it’ll be an issue for fundraising, too. To get the attention of someone who can write a substantial check, or of enough small-time crowdfunders to make a difference, entrepreneurs will need to work harder rather than less hard to differentiate in a noisier, more competitive marketplace. It takes a lot of online “friends” kicking in a few hundred dollars to raise any real
money, and thousands of companies will now be competing for the crowd’s dollars. For Angel Capital Group, we see this as yet another opportunity for us to leverage the scale of activities and opportunities in our network to bring the best ideas and innovations to our valuable Angel investor base, and to offer our investors as many competitive advantages as possible. We will continue to provide companies with an efficient and personal way to raise money from our Angel Investor members and pair that with online crowdfunding, giving anyone access to our deals. We’ll utilize the new crowdfunding freedoms to improve all aspects of our current offering to investors: deal flow, closing funding rounds, increased deal scrutiny, and gaining access to premium investment opportunities. Channeled through our multi-regional network, crowdfunding will be both powerful and controllable, occurring through our proprietary investment portal MyAngelPortfolio.com, thus enabling us to protect Angels’ stakes from feeding frenzies or less-than-ideal terms in any investment. Crowd-type investors will only have access to deals after our Angels have approved the deal on their own. By giving our stamp of approval, entrepreneurs will receive a boost in credibility and better chances in the crowd market, which we’ll assist with. The specifics of the crowdfunding legislation are yet to be determined; however, it’s guaranteed to transform the funding landscape for investors and entrepreneurs playing in the early- and seed-stage sandbox. We’ll be working diligently to utilize our network and capabilities to both protect and enhance investment opportunities for our Angels while increasing deal flow and funding power for our entrepreneurs. The startup world is about to get supercharged. We’ll be helping our members keep up!
a g l i m p s e o f w h at ' s a h e a d
KC’s Crossroads Art and Design District is a hotbed for entrepreneurs and tech startups.
kansas city: no longer flyover country
F o l l o w J a s o n g r i l l o n T w i tt e r
twitter.com/jasongrill
There's a reason we chose Kansas City to be the home of ACG's new Midwest headquarters. This once docile prairie town is quickly becoming an entrepreneurial juggernaut, and we're not the only ones catching on.
The Kansas City metropolitan area is becoming the envy of individuals on the East and West coasts who have long since considered it merely flyover country. The City of Fountains has been praised as a great place to live, work and visit for many years, but recently it is becoming a hot bed for entrepreneurial investment, high culture and the innovations of the future.
Kansas City, Missouri, is home to the world renowned Kauffman Foundation. The foundation’s mission is to help individuals attain economic independence by advancing educational achievement and entrepreneurial success. The Kauffman Foundation’s focus on entrepreneurship, innovation, education, and research has helped fuel Kansas City’s global presence as an attractive place for creativity and business. Nearly 300,000 individuals from throughout the world have been part of the Kauffman FastTrac program, which has helped entrepreneurs start and grow their business. In addition to the Kauffman Foundation, the University of MissouriKansas City’s Institute for Entrepreneurship and Innovation Graduate Entrepreneurship Program was recently named the 2012 National Model Graduate Entrepreneurship Program by the United States Association for Small Business and Entrepreneurship (USASBE). Entrepreneurship is booming and alive in Kansas City. The entrepreneurial spirit in Kansas City has led the city to become a national leader in technology. Google recently announced it will build its first ultra high-speed broad-
band network between Kansas City, Missouri and Kansas City, Kansas. Kansas City was chosen over 1,100 other cities. Google Fiber will deliver Internet speeds more than 100 times faster than what most Americans experience. The Wall Street Journal recently coined Kansas City as “Silicon Prairie” and believes that the first Google Fiber network “will likely bolster cloud-based technologies and pave the way for high-definition streaming services that will be hard to find elsewhere.” Combine this with the friendly business climate on the state and city levels and the low cost of living, and you will understand how Kansas City is gaining innovators and entrepreneurs from coast to coast. Entrepreneurship and innovation have also led to Kansas City, Missouri becoming a thriving arts and cultural community. In late 2011, The Kauffman Center for the Performing Arts opened its doors. The $326 million dollar center was paid for through all private donations and sits in the heart of the Kansas City Crossroads Arts District, which has become a hub for artists, digital media and advertising firms, filmmakers, and forwardthinking businesses. The area also is home to the offices of Kansas City’s Major League Soccer franchise, Sporting KC, who recently built the nation’s most innovative and high tech soccer specific stadium in the country Livestrong Sporting Park. Entrepreneurship, innovation and a thriving arts scene all add up to Kansas City being a city on the move. Take a chance on Kansas City, you won’t be disappointed.
a y e a r i n r e v i e w : f u n d i n g o u r to m o r r o w
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kansas city / no longer flyover country
TOP The brand new Kauffman Center for the Performing Arts, located in downtown KC, is home to the KC Opera, KC Symphony and KC Ballet above left KC’s downtown is home to a number of headquarters like H&R Block and Hallmark. above right With more fountains than Rome, KC is known as the “City of Fountains.”
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From Google’s ultra high-speed fiber network and world-class tech assets to a diverse and skilled IT workforce, the Kansas City area is receiving global recognition for its thriving entrepreneurial ecosystem. With brand-name headquarters such as Sprint, Garmin, Cerner, H&R Block and Hallmark, Kansas City has a legacy of entrepreneurial support and success. Many national news sources have profiled Kansas City’s business and lifestyle assets.
kansas city: On the rise
No.16 No.7 Top10 No.10 Top7 Top4 No.20 Top
Best Cities for Jobs New Geography, May 2012
Recent College Grads Forbes.com, March 2012
Tech Industry Job Growth IT World, March 2012
One of America's Techiest Cities Travel + Leisure, jan. 2012
Innovative Center for Information Technology
Kansas City has a legacy of artistic and entrepreneurial innovation spanning more than 125 years. Today, the KC metro has one of America’s most inventive and creative cultures. With companies and people that design the world’s top sports stadiums, lead the digital revolution of health care, plug-in the world with all-electric trucks, help deliver safe water around the globe and win the Pulitzer Prize for music, Kansas City is a thriving national hub for arts and innovation. Sparked by unbounded energy and ingenuity, KC has the fourth largest concentration of graphic designers, and the seventh largest concentration of visual artists. Undergoing a major arts renaissance, the KC region is a mashup of American creativity – the intersection of artistry and technology. For more visit KCCreativeCrossroads.com.
wall Street Journal, August 2011
Entrepreneurial Cities to Watch entrepreneurs unpluggd, july 2011
America's Best Cities for Hipsters Travel + Leisure, april 2012
Android App Producing Cities venturebeat.com, August 2011
KCnext – The Technology Council of Greater Kansas City serves as the regional advocate for Kansas City’s technology industry, supporting more than 80 tech council members, and growing. KCnext is committed to growing the existing base of technology firms, recruiting and attracting technology companies, aggregating and promoting KC’s regional IT assets and providing peer interaction and industry news. By focusing on key industry priorities, KCnext works to connect, promote and support the KC region’s tech industry. For more information, visit KCnext.com. a y e a r i n r e v i e w : f u n d i n g o u r to m o r r o w
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Tax Credits
Government Incentives for Angel Investors
Many states recognize the importance of early- and seed-stage investing
to the health of their economies. We compiled a state-by-state list of Angelfriendly incentives —read on to see if you qualify for any of them.
state
tax incentive name
max credit
summary
Arizona
Small Business Capital Investment Tax Incentive Program
35%
Amount Invested Investment
Equity Investment Tax Credit Incentive Program
33.3%
Colorado
Colorado Innovation Investment Tax Credit
15%
Hawaii
Hawaii High 100% Technology Business Investment Tax Credit
Indiana
Indiana Venture Capital Investment Tax Credit
20%
Kansas
Kansas Angel Investor Tax Credit
50%
Arkansas
Kentucky
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of at least $25,000 cash or cash
No
Financial Requirement Does not have assets exceeding $2M, exclusive
of intellectual property and any qualified investment. Has not received aggregated qualified investments in excess of $2M by all qualified investors in all years. Percent For a qualified bioscience or rural company, the tax credit may total up to 35% of the investment amount over three years; for any other qualified business, the tax credit may total up to 30% over three years. Amount Invested No restriction Financial Requirement No restriction Percent The equity investment tax credit
Yes
Amount Invested The
investment must be an equity security of at least $25,000 made during calendar year 2010. The investor, and it’s affiliates, have no more than 30% (immediately preceding the investment) of the total voting power of all equity securities of the business. Financial Requirement Have yearly revenues of less than $2 million and total assets of less than $5M (excluding any investment that is the basis of a Colorado Innovation Investment Tax Credit). Percent The tax credit is calculated by multiplying 15% times the qualified investment up to the $20,000 maximum allowable tax credit amount (per taxpayer id).
No
Amount Invested There
is no minimum investment but there is a cap of $2M per investor per qualified business per year. Financial Requirement None, but there must be some expenses to be considered engaged in qualified research; more than 50% of total activities must be in qualified research. Percent 100% credit is taken over 5 years, but front loaded 35% in year 1, 25% in year 2, then 20%, 10%, and 10%.
Yes
Amount Invested No restriction Financial Requirement Has had
No
Amount Invested No restriction Financial Requirement None Percent A tax credit shall be equal
Yes
Amount Invested No restriction Financial Requirement The company’s net worth is less than $5 million
Yes
incentive shall be equal to thirty-three and one-third percent (33 1/3%) of the approved amount invested by an investor in an eligible business.
Kentucky 40% Investment Fund Tax Credit
a n g e l c a p i ta l g r o u p
equivalent
transfer
average annual revenues of less than ten million dollars ($10,000,000) in the two (2) years preceding the year in which the business received qualified investment capital from a taxpayer claiming a credit under this chapter Percent The lesser of the total amount of qualified investment capital provided to the qualified Indiana business in the calendar year, multiplied by 20% or $500,000.
to the lessor of $50,000 or 50% of an Angel Investor’s Qualified Cash Investment in a single business.
(or $10 million, if it is a knowledge-based business) or its net income in each of the prior two years is less than $3 million Percent The Kentucky Investment Fund Act (KIFA) offers a 40% tax credit to certain personal and corporate investors in approved investment funds.
tax credits
state
tax incentive name
max credit
summary
transfer
Maine
Maine Seed Capital Tax Credit
60%
Amount Invested No restriction Financial Requirement Annual gross
Yes
Maryland
Maryland Biotechnology Investment Tax Credit
50%
Amount Invested Individual or any entity who invests at least $25,000
No
Minnesota
Seed Capital investment Credit
45%
Amount Invested No restrictions Financial Requirement Has its principal office in a border city (Brecken-
No
Angel Investment Tax Credit
25%
Amount Invested The
minimum qualifying investment is $10,000 (investors) and $30,000 (funds), and the maximum credit per business is $1 million. Financial Requirement Qualifying businesses must be headquartered in Minnesota and have fewer than 25 employees, with at least 51 percent of the workers and total payroll based in the state. Businesses must have been operating for no more than 10 years and cannot have received previous equity investments exceeding $2 million. Percent The bill will provide a 25% tax credit for angel investors up to $125,000 per year per investor.
Unknown
10%
Amount Invested No restriction Financial Requirement None. However,
Unknown
Amount Invested No restriction Financial Requirement a qualified
No
Amount Invested None Financial Requirement Total
No
Amount Invested ? Financial Requirement ? Percent The credit is 25
No
Minnesota
New Jersey High Technology Investment Tax Credit
sales of less than $3 million. Certificates issued with respect to any one business may not exceed an aggregate of $5,000,000 in investment(s), and certificates issued with respect to any one fund may not exceed $5,000,000 in credits (provided that no such fund or group of funds or investors may seek credits for any more than $5,000,000 of aggregate investments in any one business). Percent It’s equal to 40% of qualified investment (60%, if the investment is in a business located in a certain high-unemployment area). in a Qualified Maryland Biotechnology Company. Financial Requirement None Percent Provides income tax credits equal to 50% of an eligible investment for investors in qualified Maryland biotechnology companies.
ridge, Dilworth, East Grand Forks, Moorhead, and Ortonville) and has the majority of its business activity performed in a border city, except sales activity, or has a significant operation in a border city that has or is projected to have more than ten employees or $150,000 of sales annually. Percent 45% of investment during a year not to exceed $112,500 for each year.
New Mexico
Angel Investment Tax Credit
25%
New York
Qualified Emerging Technology Companies
20%
North Carolina
North Carolina Qualified Business Investment Tax Credit
25%
the company must employ fewer than 225 employees, of which 75% must have jobs in New Jersey. Percent A taxpayer may claim a tax credit in an amount equal to 10% of the qualified investment made by the taxpayer during the tax year in a small-New Jersey-based high-technology business. business should not have had gross revenues in excess of five million dollars ($5,000,000) in any fiscal year ending on or before the date of the investment Percent 25% of the qualifying investment in a high-technology or manufacturing business. The maximum investment for which a credit will be allowed for a business is $100,000. annual product sales are $10 million or less. The company’s primary products or services must be classified as emerging technologies under Public Authorities Law section 3102e to qualify for the Qualified Emerging Technology Company Capital Tax Credit (QETC) Percent 10% of qualified investments, provided the taxpayer certifies that the qualified investment will not be sold, transferred, traded, or disposed of during the four years following the year in which the credit is first claimed (maximum credit of $150,000 per taxpayer) or 20% of qualified investments, provided the taxpayer certifies that the qualified investment will not be sold, transferred, traded, or disposed of during the nine years following the year in which the credit is first claimed (maximum credit of $300,000 per taxpayer).
whichever is less.
% of the amount you invested or $50,000,
Continued on next page >
a y e a r i n r e v i e w : f u n d i n g o u r to m o r r o w
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tax credits
state
tax incentive name
max credit
summary
transfer
North Dakota
North Dakota Seed Capital Investment Tax Credit
45%
Amount Invested No restriction Financial Requirement Must meet
no
Ohio
Ohio Technology Investment Tax Credit
30%
Ohio entity can receive up to $1.5M in investNo ments that qualify for tax credits. This amount remains the same for EDGE or Distressed Area enterprises. Financial Requirement The company must have had gross revenue of less than $2,500,000 or a net book value of less than $2,500,000 in the last completed fiscal year. Percent The amount of the tax credit is 25% (or 30% in some limited cases) of the amount invested by the taxpayer. If an investor is investing in an Encouraging Diversity Growth and Equity (EDGE)- qualified entity, or an entity in a “distressed county,” the amount of tax credit is 30% and the maximum investment to which the credit can be applied is $300,000.
Oklahoma
Oklahoma Small Business Capital Credit
30%
Amount Invested ? Financial Requirement Capitalization
Oregon
University Venture Development Fund Tax Credit
60%
Rhode Island
Rhode Island 50% Innovation Tax Credit
North Dakota primary sector certification and must bring in revenue from outside the state. Maximum aggregate amount of qualified investment in any one qualified venture is limited to $500,000 Percent 45% tax credit of the amount invested up to $112,500 Amount Invested The
of the qualified business capital
No
company must be at least $1M. Oklahoma Tax Credit for investment in business located in metropolitan area (Small Business Capital Formation Incentive Act) or 30% Oklahoma Tax Credit for investment in business in rural area(Rural Venture Capital Formation Incentive Act) Percent 20%
Amount Invested No restriciton Financial Requirement Not applicable
No
Amount Invested No restrictions Financial Requirement Has annual
No
since this tax credit is for investments in universities and not companies Percent Any taxpayer who makes a qualifying charitable donation to an Oregon university venture development fund is eligible for the credit. The taxpayer’s credit is 60 % of the amount stated on the tax credit certificate. gross revenues of less than $1M in
the prior two calendar years. credit on eligible investments, with maximum tax credit of $100,000. Percent 50%
Virginia
Virginia Qualified Equity and Subordinated Debt Investments Credit
50%
Amount Invested Has
annual gross revenues of no more than $3M in its most recent fiscal year. Has not obtained during its existence more than $3M in aggregate gross cash proceeds from the issuance of its equity or debt investments (not including commercial loans from chartered banking or savings and loan institutions). Financial Requirement Effective January 1, 2009 a qualified business means a business which has annual gross revenues of no more than $3M in its most recent fiscal year and has not obtained during its existence more than $3M in aggregate gross cash proceeds from the issuance of its equity or debt investments (not including commercial loans from chartered banking or savings and loan institutions). Percent The credit is equal to 50% of the qualified business investments made during the taxable year.
No
Wisconsin
Wisconsin Angel Investor Tax Credit
25%
Amount Invested Have
No
not received more than $1M in investments that qualify for angel investment tax credits.Have not received aggregate private equity investment in cash of more than $10M prior to being certified. Financial Requirement Businesses can receive up to $4 million in tax credit-eligible cash equity investment, of which no more than $1M in tax credit-eligible investment can come from angel investors. Percent 25% tax credit over 2 years (equal to 12.5% in each of 2 years).
The above Tax Credits table is a modification of the table put together by The Connecticut Technology Council. Data sources include each state’s government website and interviews with state Economic Development Department officials, state tax officials and angel investors. Author: Ezugo Nwosu | MBA Candidate, Class of 2010 | Carnegie Mellon University | Pittsburgh, Pennsylvania | email: ezugo_nwosu@yahoo.com
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a n g e l c a p i ta l g r o u p
angel investing in real time
our portfolio companies
From healthcare to storage to innovative imaging and geolocational social media, ACG has a stake in some of tomorrow's big hits (in our humble opinion).
Profile no. 1
Company Name OptiVia Medical LLC CEO Name Position Open Total Capital Raised To Date $3M Year Founded 2004 What does your company do? OptiVia Medical LLC is a medical device development company. The focus is a patented technology platform for visually guided steerable endo delivery systems. The initial focus is to facilitate an office GYN procedure, hysteroscopy. The second product, based upon the technology platform, is a visually guided and steerable instrument for spinal surgery enabling multiple level micro discectomy procedures on an ambulatory basis.
with positioning their endeavors for fund raising. Fund raising from this viewpoint is a necessary evil. Assistance from major corporation interested in the technology as a future marketable product for them could significantly streamline the process. What advice do you have for entrepreneurs raising money? Bring in sea-
soned business experts at the start to set you on right path of creating a company that can be built upon or sold at an attractive profit/incentive for everyone involved. The timeline is as crucial as the amount of funds. Be aware of what you are raising today and how it impacts the company in the future. Are you going to become an Angel Investor when you exit? Why or why not? Yes! It is a thrill to be involved in a start-
up, but more importantly to assist others from what I have learned the hard way.
How Did Funding Change Your Company? Funding enabled the development of
a patented concept to be developed to a FDA cleared device poised for an initial production run at this time.
Profile no. 2
How do you think access to capital could be made easier for future entrepreneurs? In this field most entrepre-
Company Name InQ Biosciences Corp.
neurs are technology driven and challenged
Capital Raised To Date $4,809.000
CEO Name Russell K. Garlick
Year Founded 2008 What does your company do? InQ Bio-
sciences supplies leading edge cell research instruments that bring a higher level of capability, productivity, and information technology to the biology laboratory. InQbio’s InQTM (“ink”) creates a high fidelity representation of the in vivo (“in the body”) environment for studying sensitive nerve, brain, and other human cells including stem cells for disease research, cancer biology, developmental biology, cell signaling and interactions. For the first time, cell biology and genomic researchers will be able to study these sensitive cells outside the human body, in an environment very similar to what they would experience were they still inside the human body. How Did Funding Change Your Company? Four angel investment rounds have
enabled the company to move out of the crude proof-of-principle prototype stage to having an initial manufacturable-in-quantity market-ready product. Friends-and-family and random angels cannot fund companies to this level, and the venture community’s interests lie after revenues have begun, so the organized angel groups that funded us have been essential.
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our portfolio companies
What does your company do? KCBX is
are a definite step up from the random angels. The organized groups need to get better at performing diligence in a common way so that deals can be syndicated more easily among them.
investment made by ACG with no additional work for the presenter, so that would make access to capital easier. Having said that, we’ve never worked with a more efficient angel investment group than ACG. They provided phenomenal support and professionalism. And they were pleasant to work with!
What advice do you have for entrepreneurs raising money? Learn to tell
What advice do you have for entrepreneurs raising money? Get a good law
allowed the company to implement an agreement with GE Healthcare to distribute our NTrainer product in the United States.
How do you think access to capital could be made easier for future entrepreneurs? The “organized” angel groups
your market demand and business value creation story in such a way that ordinary folks, with no knowledge of your technical domain, can understand and identify with it. Simplify the terminology, remove the acronyms, and use realworld analogies to help with the understanding.
firm—one experienced in keeping start-ups squeaky clean—to ensure that all of your efforts are SEC-compliant.
Are you going to become an Angel Investor when you exit? Why or why not? All of us on the leadership team at In-
credited investor and intend to stay that way. Angel investment is how the best ideas become reality.
Qbio have been angel investors for a long time. We expect InQbio’s success to expand our ability to provide capital to successive waves of new companies.
Profile no. 3
Company Name Lead Horse Technologies,
Inc. CEO Name John M. Armstrong, Ph.D. Capital Raised To Date $4.2M Year Founded 2006 What does your company do? Lead Horse is a Personalized Medicine Company that markets the Medloom Clinical Decision Support (CDS) system. Medloom uses several patent-pending Health IT technologies to reduce Adverse Drug Events (ADEs). One of those technologies involves applying advanced artificial intelligence analytics to millions of real-world ADE case reports to identify patterns of patient profiles in which drug combinations are significantly linked to life-threatening outcomes. Once bolted onto an existing Electronic Medical Record (EMR) system, Medloom cross-references its AIdriven risk patterns to all patient records in the EMR to identify patients at risk. How Did Funding Change Your Company? ACG funding enabled Lead Horse to
Are you going to become an Angel Investor when you exit? Why or why not? I’m already registered as an SEC-ac-
Profile no. 4
Company Name TrakLok Corporation CEO Name Thomas Mann
turn-out at each of our in-person presentations would likely have increased the final
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How Did Funding Change Your Company? The most recent round of funding
How do you think access to capital could be made easier for future entrepreneurs? Somehow bringing angel
investors and early stage and start-up companies together more efficiently. A sweet spot is $1-4 million rounds. New companies need the risk capital that angel investors are willing to invest but it is difficult for such small companies to deal with the number of angel investors needed to raise that amount of capital. Currently companies are forced to go to venture firms willing to provide seed capital which denies good opportunities to angel investors. What advice do you have for entrepreneurs raising money? Persistence.
Capital Raised To Date $4.6M Year Founded 2008 What does your company do? TrakLok
Corporation is a product and service company deploying a solution to secure and globally track shipping containers and cargo. How Did Funding Change Your Company? Funding allowed us to complete the
Product design process for our Locking System and our Lock Portal. What advice do you have for entrepreneurs raising money? Make sure you
have a good understanding of your market, the costs required to complete your product, and the cost to go to market. Are you going to become an Angel Investor when you exit? Why or why not? Yes. I have always enjoyed working
with Start up companies and will continue to do so on every level that I am able to.
Profile no. 5
bolster its IP portfolio, expanding patent protection to several nations around the globe. How do you think access to capital could be made easier for future entrepreneurs? Better attendance/ angel
a commercial stage medical device company developing and selling products that address the overwhelming problem of feeding incompetency in infants and new borns.
Company Name KC Biomedix, Inc CEO Name Mike Peck Capital Raised To Date $9.3M Year Founded 2006
Profile no. 6
Company Name Screampoint International,
LLC CEO Name Michael Jansen Capital Raised To Date $4M Year Founded 2009 What does your company do? Scream-
point is a Sequoia Capital-backed, globalleading software technology firm that provides comprehensive 5D SMART™ technology solutions to government agencies, master developers and corporate leaders that collect, connect and communicate complex data sets through a 3D visual model of a city. The firm’s core software development platform, 5D SMART City, provides the environment for the use of SMART Apps™ that enable key organizational stakeholders, consultants, and solutions providers alike to benefit from easy access to a diverse array of real-time data across multiple functional areas through a single web-based visual dashboard. How Did Funding Change Your Company? During our Seed Round, Screampoint
developed our Cloud-based software development, city-as-a-platform product, 5D SMART City™. As we entered a Series A Round, we re-
the
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Geography of our portfolio
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1 Optivia Winston Salem, NC 2 InQBio Huntsville, AL 3 Lead Horse Junction City, KC 4 Traklok Knoxville, TN 5 KC Bio Kansas City, MO 6 ScreamPoint Menlo Park, CA 7 Pearescope New York, NY
quired funding to develop SMART Apps that work with the 5D SMART City platform, further develop markets and hire insanly great, key personnel. The Angel funding we received during this Series A Round is providing the fuel for us to accomplish these goals and has accelerated our growth process, not just with cash, but with direction, connections and guidance. How do you think access to capital could be made easier for future entrepreneurs? The more there is a match
between start up innovators and like minded investors, the stronger the US becomes in its ability to innovate, create and bring to market fresh ideas into reality. What advice do you have for entrepreneurs raising money? Don’t be dis-
couraged by hearing things like, “I don’t see it...”, “This is not for us...” and other throw away phrases that some investors use. Like dating, not everyone will be attracted to your company. But when there is interest, nuture it, as it is a relationship, Building trust, providing transparency and delivering what you say will achieve are the cornerstones to a successful venture. Are you going to become an Angel Investor when you exit? Why or why not? I believe the majority of the leadership
at Screampoint would become Angel Investors due to the positive experience we have had and knowing the tremendous impact an Angel fund can have on emerging great ideas and gowing busineses. Profile no. 7
Company Name Pearescope, LLC CEO Name Evan Walther
8 Sun Pro-Tec Systems Memphis, TN 9 Signix Chattanooga, TN 10 Facebook Menlo Park, CA 11 OpenAmplify Anapolis, MD 12 AB Pathfinder Olathe, KS 13 Matchpoint Careers New York, NY
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Capital Raised To Date $365,000 Year Founded 2009 What does your company do? Pearescope is creating location based social context for organizations and developers for web and mobile applications. How Did Funding Change Your Company?
In this case funding allowed for wasteful spending, and expensive mistakes. Since I have become CEO, we’ve gotten the spending under control, and while we continue to make mistakes as we learn and build our business, the mistakes are much less expensive. How do you think access to capital could be made easier for future entrepreneurs? Crowd-sourced funding. What advice do you have for entrepreneurs raising money? Narrow your
focus, find cheap ways to test your theories, and build on paper, and then on Photoshop, before you actually build your product. Are you going to become an Angel Investor when you exit? Why or why not? Yes, with the experience of a successful
exit, I’d like to be able to contribute to multiple projects at once, and angel investment is one great way to do that. Profile no. 8 Company Name OpenAmplify CEO Name Mark Redgrave Amount raised to date Private About OpenAmplify is a technology compa-
ny specializing in natural language processing and text analysis. Over the past 7 years, they have developed a multi-patented text analysis platform that has been road tested
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in real-world commercial applications. They have worked with hundreds of customers over the past few years and some of the largest ad and media agencies using OpenAmplify technology every day. Profile no. 9 Company Name AB Pathfinder CEO Name Jeff Blackwood Amount raised to date Private About ABPathfinder’s mission is to help children with Autism live more social lives. By providing simple, effective tools to support ABA-based therapy, they hope to contribute to the advancement of ASD children in meeting their full potential.
Profile no. 10
Company Name Matchpoint Careers CEO Name Paul Basile raised to date $1.5MM About Matchpoint Careers is the first fully automated use of performance-predicting science to place the right people in the right jobs. Matchpoint Careers is not a job board, it is not job search. It is job-person matching based on the scientifically validated predictors of success in each job.
With this, employers substantially increase the likelihood of placing the right person in the right job. Candidates increase the likelihood of securing a job and career that they will enjoy and where they will perform.
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Preferred Deal Structures Start-up companies
Equity Structures for High-Growth Companies By Philip N. Krause, © 2012. All rights reserved.
can generally be categorized as either
growth-model companies or revenue-model companies. Growth-model companies are characterized by developing scalable goods or services with substantial market capture opportunities, and then pursuing a plan of exponential growth in anticipation of an exit transaction. The founders plan to realize wealth primarily from the exit transaction rather than through distributing profits. Growth-model companies may operate at a loss for a substantial period, sometimes lasting until an exit transaction occurs, and are likely to require outside investors to fund their capital requirements. Revenue-model companies, by contrast, are typically structured for the founders and other owners to realize wealth by generating revenue and operating at a profit to be distributed periodically. Although these companies may have substantial growth opportunities, they are not as well-suited for outside investors because they do not anticipate an exit transaction in the foreseeable future. The equity structure for growth-model companies is quite different than for revenue-model companies. This article focuses on the unique characteristics of the equity structure for a growth-model company. For simplicity of discussion, this article will use a corporation model, with shares of stock of various classes, rather
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than a limited liability company (LLC) model. However, LLC “units” (rather than using LLC percentage interests) having essentially the same characteristics as corporate stock can be created in an LLC operating agreement. Additionally, these same concepts apply regardless of the jurisdiction in which the company is organized. Shares: Authorized, Issued, Outstanding, Treasury
A company’s “authorized” capital stock can be thought of as the company’s inventory of shares—they are in a sense “on the shelf ” and ready to be sold and issued whenever needed. So long as shares are authorized but unissued, they do not represent any ownership rights—they are dormant
for all purposes. When shares are taken off of the shelf and “issued” they become a part of the company’s “outstanding” shares. The process of issuing shares involves the prospective stockholder transferring something of value to the company, usually cash or property, and in exchange the company issues the shares being purchased and delivers to the stockholder a certificate that indicates the number of shares registered in the name of the stockholder according to the company’s stock records (called a “stock ledger”). A company’s ownership is represented by its outstanding shares, with all the issued and outstanding shares collectively representing 100% ownership. Any single stockholder’s equity owner-
preferred deal structure
ship percentage is equal to the number of issued and outstanding shares registered in the stockholder’s name, divided by the total number of all the issued and outstanding shares. The “par value” of a share of stock represents the minimum amount of money (or value of property) that the company may accept as a stockholder’s capital contribution in order to validly issue the share. The amount a stockholder contributes certainly can be more than the par value, but not less. The par value of shares issued is represented as “stated capital” on the company’s balance sheet, and any excess over par value received by the company for the shares is represented as “additional paid in capital.” In most cases the company may not issue shares in exchange for a promissory note or a promise to perform future services. Additionally, shares issued for services previously performed can present significant tax issues and may be treated as taxable income to the stockholder. When the company has received at least the par value of shares to be issued, and the shares have been properly represented by a stock certificate that has been delivered to the stockholder and recorded in the stock ledger, then the shares are considered to be “validly issued, fully paid and non-assessable.” When a stockholder owns validly issued, fully paid and non-assessable shares, then the stockholder cannot be required to contribute additional capital to the company (unless the stockholder has agreed to a contractual requirement for contributing additional capital). The stockholder also is then entitled to exercise the typical rights of a stockholder, i.e. voting, inspection and dissenter’s rights. A stockholder’s voting rights entitle the stockholder to vote for members of the board of directors and on certain substantial corporate events outside of the ordinary course of business (e.g. amendment of the articles of incorporation, merger with another company). A stockholder does not have the right to participate in the company’s management otherwise
than through the exercise of a stockholder’s voting rights. In certain situations a company may repurchase or “redeem” its own shares from a stockholder. A company is not permitted to redeem its own shares if doing so would render the company insolvent or otherwise impair the company’s capitalization. When a company redeems shares, the company may either cancel those shares, in which case they either return to the inventory of authorized but unissued shares or are cancelled and disappear entirely (reducing the company’s authorized shares), or the shares become “treasury shares” owned by the company. A company does not have any stockholder rights (such as voting) for shares held in treasury. However, this affects how the shares are reflected on the company’s balance sheet and also would permit the company to later resell those same treasury shares for less than their par value. Shares: Common and Preferred Stock Classifications
A company may “classify” its shares into various classes having different kinds of rights. The two major classifications of shares are “common stock” and “preferred stock.” Common Stock. Common stock is the foundation of a company’s equity structure. It is the last class of stock (or lowest in order of priority) to receive any dividends or other distributions to the stockholders, so in this sense common stock represents the highest risk of equity ownership. However, in any liquidation of the company and distribution of assets to the stockholders following a liquidity event, the common stock also typically receives all of the remaining assets available for distribution after satisfying all prior rights, so that common stock may also represent the highest opportunity for upside return. Consequently, common stock usually matches highest risk to highest return opportunity. A company’s common stock may be further divided into sub-categories or
“classes.” For example, classes of common stock may be created that have no voting rights. Non-voting common stock is often used for stock grants or stock options to key employees, giving them an opportunity to share in a company’s upside return but no opportunity to influence the company’s decisions through voting rights. Similarly, classes of common stock may be created that have voting rights greater than one vote per share, thereby giving that class of stock greater control of corporate decisions requiring stockholder votes. A frequent use of classified common stock is to create classes of directors that are elected by the corresponding classes of common stockholders. For example, a company could have a board consisting of five directors, with three “class A directors” and two “class B directors.” The class A directors would be elected by the holders of class A common stock, and the class B directors would be elected by the holders of class B common stock. This would mean that the class A stockholders control a majority of the board of directors regardless of the relative numbers of outstanding shares of class A and class B common stock. Other Equity-Interests. An early stage company may need to borrow money when it lacks creditworthiness for traditional financing. This indebtedness is often accompanied by a right of conversion into a class of the company’s equity securities, based on a conversion ratio and an implied company valuation. Bridge loan financing, as described below, is an example of convertible debt. Additionally, warrants are often used as a means to enhance an investor’s potential investment return. Warrants are essentially an option to purchase shares of a company’s equity securities at a specified price, and sometimes upon the occurrence of a specified event (e.g. a subsequent round of equity financing, or a liquidity event). Warrants may be “attached to” and accompany convertible debt securities or any equity securities. Additionally, financial
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preferred deal structure
Preferred Stock Preferred stock, just as its name signifies, represents a higher classification of equity ownership relative to the common stock, i.e. preferred stock typically represents the right to receive a priority or “preferred” return on investment, through preferential dividends and preferential rights in any liquidating distribution. The terms and conditions of preferred stock are highly flexible, and can be tailored to meet the specific circumstances of the transaction in which shares of preferred stock are being sold and issued. Here are some examples of terms and conditions that may be used for preferred stock:
»» Preferred
»» “Redeemable”
»» Preferred may receive preferential distributions in a liq-
»» Special voting rights, in which preferred stock gets more
uidation of the company, in which preferred stock is paid all accumulated but unpaid dividends, plus the original investment amount, prior to making any distributions for common stock.
votes than one-vote-per-share, or votes for a special class of directors (similar to class A and class B directors as described above).
stock may receive a stated rate of return, expressed as dividends calculated as a percentage of the original investment amount (similar to interest on a loan). Preferred dividends can be paid on a periodic basis (e.g. quarterly or annually), or they can be “cumulative” so that they build up or accumulate over a time (perhaps with periodic compounding) until the company begins paying dividends or is liquidated. In most instances, all preferred dividends must be paid before any dividends may be paid on common stock.
»» “Participating”
preferred stock receives both a liquidation preference in priority to common stock, and then also participates in any liquidating distributions to the common stock.
»» “Convertible” preferred stock allows preferred stockholders to choose between the preferential returns to preferred stock, or the potential unlimited upside returns to common stock, so that the preferred stockholders can choose between the “best of both worlds” between common and preferred stock.
»» Preferred stock may be subject to “mandatory” conversion to common stock in certain circumstances, such as when a company goes public through an initial public offering.
preferred stock permits the company to buy back or redeem the preferred stock by paying the preferred rate of return plus the original investment amount. Redemption of preferred stock may be made “mandatory” so that a company has a deadline by which preferred stock is required to be redeemed. Mandatory redemption is often coupled with conversion rights, so that the preferred stockholder can decide whether to take the buy-out now (at the time of mandatory redemption), or stay in the deal along with the common stockholders.
»» The
company may establish “covenants” with the preferred stockholders, so that certain events are prohibited (“negative covenants”) without their approval (e.g. selling more shares or borrowing more money), and also so that the company must take certain actions (“affirmative covenants”) unless they otherwise approve (e.g. providing periodic financial statements).
»» Preferred stock may have “anti-dilution” protection so that their relative ownership percentage in the company is protected when additional shares are issued, or “down round” protection so that their original terms get changed and they would get a better deal (e.g. additional shares) if the company subsequently issues shares based on a lower preinvestment valuation.
All of the foregoing terms and conditions of common and preferred stock are usually established in the company’s articles of incorporation. However, at the time the company is incorporated, the terms and conditions that may be needed for future issuances of preferred stock often are not known—they typically arise from negotiations with prospective investors. To accommodate this, the articles of incorporation often establish a class of “blank” preferred stock. This means that a specified number of shares are classified as preferred stock, but the terms and conditions of the preferred stock are left “blank” and are subsequently established by a board resolution. Preferred stock is often issued in sub-categories or multiple series or classes (e.g. “series A,” “series B,” etc.), and each preferred stock series can have different terms and conditions than other series of preferred stock. These terms and conditions are negotiated separately with each subsequent group of investors, depending on the facts and circumstances as then exist and the specific investment requirements of those investor groups.
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advisors who assist the company in its fund-raising strategies may obtain warrants as a part of their fee structure. Equity Structure Example
Here is an example of how a highgrowth company’s equity could be structured: • 10,000,000 shares of authorized capital stock, par value $.001/share • Of which 5,000,000 shares are designated common stock, and further classified as: »» 1,000,000 shares of class A common stock (voting) »» 3,500,000 shares of class B common stock (voting) »» 500,000 shares of class C common stock (non-voting) • And of which 5,000,000 shares are designated as “blank” preferred stock (with the rights and preferences to be determined by the board of directors as and when issued) Using this equity structure, a company’s capital funding would often occur in a sequence along the following lines: Founders. At the time the company is originally established, the founders would contribute their original capital contributions (often including any preexisting intellectual property) in exchange for class A common stock. Their initial capital contributions would indicate a nominal or minimal initial company valuation. All of the shares of class A common stock would be issued to the founders, so that this class is “closed” to any further ownership, thereby tying the founders to each other in a distinctive way by having them all own the same class of shares. The founders would establish the initial board of directors, often consisting of all the founding stockholders. Early Stage Investors. This is the funding stage that enables the founders to build the company beyond their own limited financial resources. The investors at this stage are often referred to
as “seed capital” or “angel” investors as they typically invest in earlier stage companies and require terms and conditions that are usually more friendly to the company and its founders than are likely to be required for later stage investors. These investors may also include acquaintances of the founders, often referred to as “friends and family” investors. Importantly, once the company begins to obtain investor funding outside of the founding stockholder group, the company must comply with important federal and state securities law requirements applicable to the offer and sale of securities. The early stage investors may receive class B common stock for their investments, but sometimes angel investors will require a class of preferred shares to be established for their investment. This investment is based on a stronger pre-investment valuation that the founders’ shares, but the company is likely to be pre-revenue at this time and usually cannot justify a high valuation. Thus, this round may be proportionately more dilutive of the founders’ shares than later investment rounds, and the company (and the founders) will want to raise only the minimum amount of capital in this round and wait to raise additional funding when a higher valuation can be justified. A classified board is often established at this time to assure board representation for the investors. Bridge Loan Financing. The second stage of equity funding is usually a larger and complex transaction, requiring a substantial amount of planning and potentially extended efforts to identify prospective investors and negotiate their investment transactions. When this is the case, the company may require an intermediate financing, between the early stage and second stage funding, in order to “bridge” the company’s capital requirements between these two investment rounds. This bridge financing is often structured as a loan, in which the loan has a relatively high interest rate (to reflect
the higher risk of this financing) and a relatively short maturity date (to motivate the company to be diligent in seeking the next stage of equity financing). This loan is typically convertible at the lender’s option into the securities to be offered in the second stage funding, on the same terms and conditions (including price) to be offered to those anticipated investors. Additionally, if the company has other debt financing, then this loan probably will be subordinated to the senior debt financing in order to obtain the senior lender’s consent for the company to incur additional indebtedness. This bridge loan financing is often referred to as “convertible subordinated debt.” Many of the terms and conditions of the convertible subordinated notes will be similar to the terms and conditions anticipated for the second stage funding. Additionally, in the event that the second stage funding is not obtained within the expected time frame, the lender typically has the right to convert the debt to common stock (or a prior series of preferred stock)— this allows the lender to stay in as an equity owner rather than having no choice but to extend the maturity date of the loan or to call the loan and force the company into liquidation. Second Stage Funding. This stage is sometimes described as “mezzanine” financing and is generally the first time when the company raises a substantial amount of capital financing. This is the financing stage that the company has been anticipating and hoping to facilitate with all the prior rounds of financing. Venture capital and other private equity firms are often the source of this financing. Second stage funding is more likely to be structured as a preferred stock instrument, as either series A preferred stock or as series B preferred stock (when the first round of financing was structured as series A preferred stock). Later Stage Funding. From this point on, the types, sizes and sequence of financial transactions that will be required to provide for the company’s
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preferred deal structure
on-going capital requirements vary as widely as the companies that may be formed, and often depend on the specific industry in which the company is pursuing its opportunities. For example, a technology company may pursue a substantially different financing strategy than a new drug development company. However, regardless of the funding strategies, the equity structure illustrated by this example is still likely to be robust enough to facilitate most investor requirements. Incentives for Management & Key Employees
Many early stage companies desire to incentivize their management and key employees using company equity. These are the individuals whose contribution is considered to be critical to the company’s success, without whom the com-
who obtain equity incentives should not be in a position to also vote on the board members who are their ultimate supervisors, and on significant corporate decisions that may have a personal impact on them, and therefore they should not have voting rights. The relative number of shares allocated to this class of common stock also suggests a limited pool of equity reserved for this purpose relative to the number of shares reserved for the founders and investors. Stock grants and stock options often have vesting requirements and are subject to forfeiture or repurchase if the individual leaves the company. Also, the grants or options are often accompanied by non-disclosure and non-compete requirements and an obligation to assign to the company all proprietary rights pertaining to the company’s business. These arrangements may
"By implementing a plan at the time of formation, a company not only anticipates the kinds of arrangements prospective investors may require, but it can also establish the equity framework it prefers at a time when the company is not yet subject to the control of its eventual investors." pany would be likely to fail. The concept is that, if these key individuals have a stake in the company’s upside, by sharing in any potential increase in the value of the company’s equity ownership, they will be more highly motivated to contribute their abilities and energy to help the company be successful and to grow the company’s value. In short, if they help the founders and investors achieve their goals, then they also will receive a substantial financial reward. Many strategies and methods are available for a company to accomplish this objective. For example, cash bonuses benchmarked to company performance is a straight-forward tool for incentive arrangements. The equity structure illustrated by this example provides for class C non-voting common stock as an alternative. These shares can be awarded as direct stock grants or as stock options priced to a current company valuation. The concept is that the insiders
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have significant tax consequences to both the company and the individuals receiving the grants or options. This equity structure example is merely one illustration of how a high growth company may structure its equity ownership. However, it demonstrates how a start-up company can begin to plan for its anticipated capital requirements from the very outset of its formation. By implementing a plan at the time of formation, a company not only anticipates the kinds of arrangements prospective investors may require, but it can also establish the equity framework it prefers at a time when the company is not yet subject to the control of its eventual investors. If the equity plan is wellstructured and is consistent with the requirements investors are known to commonly expect, then the plan helps support the company’s credibility and prospective investors are likely to find it acceptable.
About the Author PHILIP N. KRAUSE practices business, cor-
porate and securities law, focusing primarily on serving entrepreneurs and high-growth technology and life sciences ventures. He is an entrepreneur in his own right and has his own private law practice seeking to transform how lawyers interact with entrepreneurial clients and deliver the distinctive range of legal services they require through innovative service models. Philip’s entire professional career, spanning nearly thirty years, has been spent in the Kansas City area, and for most of that time he has affiliated his law practice with prominent Kansas City-based law firms. Philip’s broad-based experience encompasses the entire “life cycle” of high growth ventures, including structuring and organizing the enterprise, establishing relationships with key constituencies (founders, management, investors, etc.), acquiring, protecting and licensing intellectual property assets, securing capital resources through financing transactions (debt, equity, strategic partnerships, etc.), and realizing wealth through exit transactions (IPO, stock & asset sales, mergers). Philip is highly energized by students of all levels and ages who are seeking to establish their knowledgebase for pursuing their own dreams and ambitions. As an Adjunct Professor of Law for the UMKC School of Law, Philip appears frequently as a guest lecturer and has recently taught a class in “Advising Life Sciences and Technology Entrepreneurs—The Legal Life Cycles of a High-Growth Venture: Birth (Formation) to Death (Exit).” He mentors recent law school graduates as they develop their own law practices, and also law school and other graduate and undergraduate students as they develop their post-education career and business plans. As an Entrepreneur-In-Residence for the UMKC Institute for Entrepreneurship and Innovation at the Henry W. Bloch School of Management, Philip interacts directly with students who are already working to establish their own entrepreneurial ventures, helping them to identify and address their own specific legal challenges, while at the same time contributing to their educational experience in the classrooms and also developing practical, solutions-based reference materials to address start-up company challenges. Philip received his law degree from Vanderbilt University in 1983 and his bachelor’s degree summa cum laude in English and business administration from William Jewell College in 1980. He resides in the Kansas City area with his two sons, and maintains his private law office in Kansas City’s historic River Market district. He is an avid bike-rider, averaging about 50 to 100 miles per week in fair weather, and enjoys reading from his growing collection of presidential biographies.
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more about membership
We invest in innovation. Join us. Angel investors were once limited to opportunities in their personal
network of friends and family members; if they were able to find a solid
coming soon __________
Through a new partnership with Venture360 Technologies, we’re innovating the way private equity is accessed, managed, and deployed as a service to our network members. In the near future, you will have the option to:
opportunity, they had to foot legal and accounting bills that discouraged investment. If they wanted an easier investment vehicle, they had private equity or venture capital to turn to: huge minimum investments, later stage opportunities, excessive management fees, etc.
Angel Capital Group was created to offer solutions—for entrepreneurs, for investors, and for the marketplace as a whole. Over 100 ACG network members now enjoy our value-added services, deal flow and screening, and legal and accounting efficiencies through 5 of our local chapters. Our organization makes it possible for the average Angel investor to:
»» Meet Locally. Monthly chapter meetings bring successful Angels together to hear and discuss investment opportunities with the entrepreneurs who have gone through our Venture 360 deal screening process, meaning you don’t waste time with amateurs and crooks.
»» Invest Nationally. Chapter members are automatically granted access to deals that other chapter networks have chosen to invest in. This helps everyone—investors and entrepreneurs—raise enough funds to close investment rounds.
How to Join
»» Fund Your Future. We receive over 300 applications per year for funding from entrepreneurs in healthcare, energy, mobile, consumer products, and other industries. Often, we’re the first line of private equity these entrepreneurs have reached out to. After a stringent documentation and analysis process, the best prepared deals are sent to local chapters for consideration.
»» Stay in Control. Our purpose is to source, screen, and present the best startup deals to our members. There's no requirement to invest; only a comfortable environment for people who love entrepreneurship.
»» Invest with Confidence & Efficiency. Angel investing through our network allows legal, accounting, and due diligence expenses to essentially be “bought in bulk” and shared throughout the network. It’s all covered in your membership fees.
Create and manage your custom Angel portfolio online through Venture360.co. You’ll be able to review due diligence work on local and national deals, select opportunities to participate in, set your investment amounts, and track network chapters’ activities. This option will make our Angel network deals and activities accessible to busy members who aren't able to attend local chapter meetings, or for individuals in areas where Angel Capital Group does not yet have a local chapter. Simply set your annual investment commitment, pay a 5% membership fee on committed capital, and you have access to our services, deals, and network activities no matter where you happen to be.
membership levels Angel Explorer Commit an annual amount to invest and pay a 5% member fee on that committed amount. Minimum commitment is $10,000 per year. Additional investments above committed amount are subject to an additional 5% fee at the time of investment.
Angel Founder Pay a flat $5,000 annual membership fee and invest any amount however you choose. Contact Rachael Qualls at (615) 669-7026 or rq@angelcapitalgr.com.
a y e a r i n r e v i e w : f u n d i n g o u r to m o r r o w
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Start Funding Your Future
Contact Local Chapter Directors or Our Headquarters to Get Started
KANSAS CITY, MO KNOXVILLE, TN NASHVILLE, TN
JACKSON, MS
NAPLES, FL
midwest regional headquarters
kansas city, mo
Contact email phone
Michelle DeSilva michelle@angelcapitalgroup.net (816) 377-2147
southeast regional headquarters
nashville, tn
Contact email phone
BJ Howard bj@angelcapitalgroup.net (615) 828-6853
knoxville, tn Contact email phone
Eric Dobson eric@angelcapitalgroup.net (865) 235-3680
new chapter locations coming soon
Angel Capital Group is expanding into new markets. If you are interested in founding a network chapter in your local market, contact Rachael Qualls at (615) 669-7026 or rq@angelcapitalgroup.net.
entrepreneurs
Join our growing list of portfolio companies. Visit theangelcapitalgroup.com/entrepreneurs to get more information and apply for funding.
membership levels
jackson, mo
Angel Explorer
Contact
Commit an annual amount to invest and pay a 5% member fee on that committed amount. Minimum commitment is $10,000 per year. Additional investments above committed amount are subject to an additional 5% fee at the time of investment.
email phone
Dave Clements dclements@angelcapitalgroup.net (601) 209-7100
naples, fl Contact Rachael Qualls email phone
rq@angelcapitalgroup.net (615) 969-2320
Angel Founder Pay a flat $5,000 annual membership fee and invest any amount however you choose.