Angel Investing A PUBLICATION OF ANGEL CAPITAL GROUP What is Angel Investing? P.09 Trendspotting P.12 Private Equity Just Went Public P.16 Incentives for Angel Investors P.22 ANGELS YEAR THE OF A Year in Review FUNDING OUR TOMORROW "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." —STEPHAN PATERNOT
Transcript
AngelInvesting
A p u b l i c At i o n o f Angel CApitAl group
What is Angel Investing?
p.09
Trendspottingp.12
Private Equity Just Went Public
p.16
Incentives for Angel Investors
p.22
Angels
yeArtheof
A Year in ReviewFunding Our TOmOrrOw
"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 p a t e r n o t
II a n g e l c a p i T a l g r O u p
m o v e t h e n e e d l e
W e talk a lot here at the Angel Capital Group about moving the needle, by which we mean doing some-thing 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 en-trepreneur. 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 diver-sification 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 diversifi-cation). 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 in-vestments 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-for-profit 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 cre-ation. Entrepreneurs would present to these groups or deals would be shopped to the members with expertise in that par-ticular area.
I was left with a lot of questions and felt this model fell short in a couple of ways. For example:
» 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 invest-ment 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 com-pete 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 QuAllsf o u n d e r & c e o
a y e a r i n r e v i e w : F u n d i n g O u r T O m O r r O w III
ContentsFor More Information
theangelcapitalgroup.comv i s i T O u r w e b s i T e
04 Why Did You Become an Angel Investor?Local Chapter Founders on what led them to Angel investing.
05 Angels of the YearSam and Jeff McCamy talk about the transition from hands-on business to portfolio management.
08 Stages of CapitalFind out why some doors open, instead of close, when asking for money.
09 Angel Investing PrimerThe difference between Angel investing and its private equity brethren is more than just early- vs. later-stage investment.
12 Trend SpottingOur market projections and insights from work-ing on the front lines of innovation.
15 New LeadershipThree network directors bring long histories of entrepreneurial and investment experience to ACG.
16 Crowdfunding New legislation in Wash-ington D.C. could change everything about the way Americans invest their money.
21 Kansas CityThis 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 Government Incentives for Angel Investors.
25 Our Portfolio CompaniesACG's stakes in healthcare, mobile, storage, and more.
28 Preferred Deal StructuresLegal 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.
35 More About MembershipLearn more about investment opportunities and how to join Angel Capital Group.
05
10left
on the CoverSam & Jeff McCamy on what to do after a successful exit.
above
trend spottIngThe newest seed-stage startups that have our attention.
"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 p a T e r n O T
4 a n g e l c a p i T a l g r O u p
t h o u g h t s f r o m o u r f o u n d i n g m e m b e r s
AngelInvestor
why
beCoMe Andid you
Q:
"to help others achieve their goals while simultaneously diversifying my portfolio and learning from other investors along the way."
—dr. J. sheAts
"i enjoy seeing new companies with fresh ideas come to the market, and i plan to make some money at the same time.
—Joe iVey
"...for the profits, to diversify my investments and for the opportunity to invest in businesses at the beginning."—Jim mitChell "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. "
—Andrew e. gAy
"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." —steVen l. reVAre
5
AngelsyeArofthe
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 manag-ing a business to managing investments —and how Angel investing fits into their overall financial plans.
FeAture story
6 a n g e l c a p i T a l g r O u p
Angels oF the yeAr
“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 gen-eration owners of Roden Electric Sup-ply, an electrical distributor in Knox-ville, 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 be-cause of their own depth of experi-ence in growing and operating a busi-ness. 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 des-tination for the McCamys, who still have a contracting business. But in 2007, real estate proved to be a tu-
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 require-ments: it needed to be hands-on (not that they wanted to manage a busi-ness, but they at least wanted a more direct connection to the vehicles in which they were investing); it needed to be aspirational, fulfilling their de-sire 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, high-return 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 enjoy-ing 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 re-turns on the ones that don’t.’ So I just thought, ‘I’d better spread my chips across the table.’” In practice, the Knox-ville 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 invest-ments 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 find-ing serious, organized entrepreneurs with solid business plans can be dif-ficult 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 net-work of family, friends, and acquain-tances. “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 in-formation, so when they present to our group we’ve already seen the 360 degree evaluation.” Sam agreed, “Outside of the group, it’s just some-body coming to your house and show-ing you something.”
Jeff and Sam both knew their ac-
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.
Tales from the Front Lines: B R O T H E R S Sam & Jeff McCamy
a y e a r i n r e v i e w : F u n d i n g O u r T O m O r r O w 7
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 dili-gence “going it alone”.
With most of their professional expe-rience in distribution, the prospect of limiting an Angel portfolio to busi-nesses 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 An-gel Capital Group’s presentations on Angel investing through local net-works, they were intrigued enough to attend. The idea of gathering other in-vestors interested in seed- and early-stage 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 ex-plained: “ 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 al-ways 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 ex-perience, 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-
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 re-sources 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-
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.”
Of course, Angel investing isn’t the only game they play. To Sam, with a contracting business, conventional stock and real estate holdings, part-ownership 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 per-spective, 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.
does it mean to be an Angel of the Year? To us at the Angel Capital Group, it’s individuals that maintain an enthusiasm for seed- and early-stage investments, under-stand both the idealism of funding innovation and the systemic benefits of seeking high growth, and demon-strate 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 or-ganized 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 lo-cations, and it is for this that we’re happy to name them our 2012 Angels of the Year.
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.
So what
8 a n g e l c a p i T a l g r O u p
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*
CapitaloFstages 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.
CompAny stAge ideas; pre-revenue and pre-proof-of-concept
use oF Funds To build a prototype and get customer feedback
CompAny stAge proven concept with little or no revenues
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-als, organized groups, or participate in small angel funds of about $5m or less.
AnnuAl deAls 30,000+
CompAny stAge $250,000 to $1m in revenues
use oF Funds growth
VAluAtions $3mm - $10mm
resourCes venture funds range in size from $10mm - $50mm at this stage
AnnuAl deAls 3,051*cb insights
sOurce: pricewaterhousecoopers/national venture capital association moneyTree™ report, data: Thomson reuters.
Seed Fundingless than $50,000
Angel Funding$100,000 - $500,000
Early StageVenture Funding
$1M - $5M
Later StageVenture Funding
$10M +
a y e a r i n r e v i e w : F u n d i n g O u r T O m O r r O w 9
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 play-ers raise funds from other investors and take management fees and per-centages on performance, Angel In-vestors typically seek to deploy their own capital direct to the source. Second, Angels are frequently sea-soned entrepreneurs —they have been there and done that. Capital, therefore, is not the only asset An-gels bring to the table; they also of-fer wisdom and experience and can lend a guiding hand to the business-es 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 suc-cessful 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 long-established 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 lever-age this network instead of waiting around for the Angel to offer up the help.
At the end of the day, the Angel In-vestor’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 motiva-tor for Angel investors deploying capital, so the typical business that receives Angel funding can expect a uniquely committed capital part-ner in the sensitive early stages of growth.
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.
W h A t i s A n A n g e l i n v e s t o r ?
AnGel inveStinG priMer
Popular culture
What makes Angel investing unique in capital markets?
stock
exchanges
private equity
venturecapital
Angel investing
10 a n g e l c a p i T a l g r O u p
Angel investing has historically been an isolated world: wealthy entrepre-neurs making investments in new startups whenever enticing oppor-tunities appear on their radar. But technology and market incentives are leading Angels to organize into groups or networks that offer advan-tages 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 net-work benefits are but a few of the many factors bringing America’s elite class of investors together in increasingly powerful Angel invest-ment groups.
legAl expenses
Deal structures vary widely depend-ing on the nature of the startup and the industry in which it operates.
Angel investments frequently take place before a business has revenue, and sometimes before a business even exists. In fact, for a certain sub-set of Angel investors, the thrill of the hunt is all about identifying truly game-changing ideas and offering the funding and guidance neces-sary 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 vari-ables that might inhibit the busi-ness’s growth and determine how profits are shared thereafter. Addi-tionally, 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 free-dom 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 prop-er deal structure is worth spending time and money to do correctly. Le-gal 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-
a y e a r i n r e v i e w : F u n d i n g O u r T O m O r r O w 11
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.
mArket inFormAtion & insights
This is the iron-sharpens-iron adage in real life. Most Angel investors are highly independent, self-made indi-viduals. 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, busi-ness-centric focus required to launch and sustain an idea or startup is ad-vantageous to the entrepreneur, it can be limiting on the capital side of the
arrangement, inhibiting one’s abil-ity to see the forest and not the trees. Angel networks that hold weekly or monthly gatherings bring successful individuals from a range of fields to-gether to discuss ideas and share per-spectives, 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.
network BeneFits
Just the way that the solitary Angel’s investment opportunities are lim-ited by the number of deals existent in their personal network, the post-funding resources available to the funded business are limited when an Angel “goes it alone”. By contrast, pooling resources with a group of An-gels allows each individual investor to enjoy the others’ relationships, which in turn just puts more resources at the disposal of the funded business and
increases the likelihood of success.
Angel Investing attracts a unique type of investor and inspires a unique style of funding. Un-like other private equity vehicles, Angel investing is intimate and personal by design; locality, collaboration, and mu-tual commitment are essential ingredi-ents for any deal, both for Angels and the businesses they fund. Technology may be playing a role in expanding ho-rizons for people everywhere, but new social tools are also making it easier for local individuals with mutual interests to connect, invest, and build. Angel in-vesting 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 entrepre-neurs with the ideas, inventions, and services that will change our tomor-row, Angels are right there on the front lines of innovation, too. Funding a bet-ter tomorrow for us all: it’s what Angel investing is all about.
2010 rank inVEStor no. oF angEL
inVEStMEntSno. oF EMpLoyEES
Funding rEcEiVEd* ($ millionS)
bESt FinanciaL pErForMancE**
MoSt 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
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.
By nature,
top 10 AnGel inveStorS
12 a n g e l c a p i T a l g r O u p
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 capital-ism: 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 seed-stage and early startups that show the orientation of the marketplace and provide promising guides for plac-ing 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:
t h e l A t e s t m A r K e t f A d s
a y e a r i n r e v i e w : F u n d i n g O u r T O m O r r O w 13
moBile. What has always amazed us about the mobile market is how quickly break-throughs 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-to-market 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, geo-location-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-
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) leverag-ing 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, mea-suring, analyzing, and aggregating as much personal data as possible on a mobile device through bluetooth- and near-field wireless-enabled devices like heart rate monitors, sleep monitors, random reporting applications, and more.)
CleAn teCh. By now, most 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 farm-ers from growing the subsidized crop with reckless abandon, but it’s certainly not where the ROI is going to be long term.
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-
ping out of R&D and into product-to-market soon.
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 meth-odologies 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.
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 con-sumer adoption.
AgriCulture. Information is power in an industry pro-viding 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 pessimis-tic, 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 mas-sive industrial factory turned into a CSA/farmer’s coop using
the latest hydroponic technologies to grow food indoors) to com-plete 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 men-tioned above, there are plenty of ag-meets-social companies looking to streamline and modernize the relationship between consumers and farmers.
trend spottIng
2
1
3
14 a n g e l c a p i T a l g r O u p
Consumer produCts. 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 in-vestors), Snuggies (kidding,
but serious: Scott Boilen, who brought us the Snuggie, prof-ited an estimated $200 million off the idea), and any one of the ridiculous but actually pretty helpful gadgets at Home Depot.
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 im-provements 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 actu-ally buy, give it a second look!
mediCAl deViCes. From genealogically treated can-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.
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 dispos-able white doctor’s coat would be as useful to a hospital as a state-of-the-art laser system that revolutionized surgery. Some of the big winners in this space may be much more simple than we’d expect.
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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.
trend spottIng
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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.
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.
neW leAderShip
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.
W h o i s A n g e l C A p i t A l g r o u p ?
16 a n g e l c a p i T a l g r O u p
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 secu-rities. The most important for our pur-poses 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 pub-lic, 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
SEC, it cannot advertise that it has se-curities for sale. This drastically altered how companies could access capital. If you can’t advertise, how are you sup-posed 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 head-aches of dealing with regulators? The fact is that the best companies don’t go public unless they need investor liquid-ity—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 invest-ment decisions, and therefore, needed to be protected through regulation. In addition, the thought was that if some-one had enough money to be accredit-ed, 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 ac-credited 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 in-vestors were the catalyst for the incred-ible technology boom of the last 15 years
Private equity just went public.
Crowd- funding
Crowdfunding is a new topic in the world of finance, so before we discuss the current legisla-tive activity, it may help to have a quick recap of financial regulation in America. Don’t worry—we’ll only cover the relevant highlights.
a y e a r i n r e v i e w : F u n d i n g O u r T O m O r r O w 17
—we couldn’t agree more. Because Angel investors were willing to invest earlier and take on more risk than tra-ditional venture capital funds, more capital was accessible to start-up com-panies. In addition, traditional venture funds were set up to fund large com-panies 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 be-cause they didn’t need enough money. Then in August of 1988, Sun Microsys-tems co-founder Andy Bechtolsheim wrote a personal check for $100,000 to an entity that didn‘t exist yet: a com-pany called Google Inc. Google and a number of other world-changing busi-nesses and innovations, wouldn’t exist today without Angel investors.
Today, there are over 258,000 active An-gel 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, inven-tors, and startup businesses in need of capital than there are Angels to fund them. There are also millions of entre-preneurially minded citizens that de-serve a chance to fund and receive the fruits of seed- and early-stage invest-ments. 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 writ-ten, 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, Twit-ter, 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 Kick-starter, 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 un-til the fundraising goal is met, so peo-ple 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:
CrowdFundIng
» 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.
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CrowdFundIng
peerBACkers. A little more entre-preneurially focused than the cause-oriented Kickstarter, Peerbackers gives entrepreneurs a place to raise unregulated cash in exchange for...hardly anything at all. Even if a start-up 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 entre-preneurs 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 web-site):
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 com-munity more efficient, inexpensive, straightforward and legally compli-ant...Despite our progress, the current regulatory environment prevents us from pursuing the innovations we feel would be most valuable to our cus-tomers, 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 ulti-mately limited state. So what’s in the leg-islation 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
» 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 provid-ing educational materials which inform people of the risks inherent to the pro-cess.
Another notable measure: the legisla-tion does away with the 500-sharehold-er 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 pro-cess of going public.
So, what does all this mean for the An-gel investor and you? For starters, Angel investors will remain a critical class of private equity. Unlike the “crowd”, ac-credited Angels will be able to invest considerable sums of money. Unlike VCs and other private equity players, Angels will remain focused on very ear-ly- 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 neces-sary to do so.
For today’s entrepreneurs, rising above all the online noise won’t just be a mar-keting problem anymore; it’ll be an issue for fundraising, too. To get the at-tention of someone who can write a sub-stantial 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 lever-age the scale of activities and opportu-nities in our network to bring the best ideas and innovations to our valuable Angel investor base, and to offer our investors as many competitive advan-tages 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 uti-lize the new crowdfunding freedoms to improve all aspects of our current offering to investors: deal flow, closing funding rounds, increased deal scru-tiny, 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 My-AngelPortfolio.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 ear-ly- and seed-stage sandbox. We’ll be working diligently to utilize our net-work and capabilities to both protect and enhance investment opportuni-ties 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 y e a r i n r e v i e w : F u n d i n g O u r T O m O r r O w 19
kAnsAs City:no lonGer flyover Country
A g l i m p s e o f W h A t ' s A h e A d
the kAnsAs City metropolitan area is be-coming the envy of individuals on the East and West coasts who have long since con-sidered 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 entre-preneurial investment, high culture and the innovations of the future.
Kansas City, Missouri, is home to the world renowned Kauffman Foundation. The foun-dation’s mission is to help individuals attain economic independence by advancing edu-cational achievement and entrepreneurial success. The Kauffman Foundation’s focus on entrepreneurship, innovation, educa-tion, 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 Kauff-man Foundation, the University of Missouri-Kansas City’s Institute for Entrepreneurship and Innovation Graduate Entrepreneurship Program was recently named the 2012 Na-tional Model Graduate Entrepreneurship Program by the United States Association for Small Business and Entrepreneurship (US-ASBE). 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 ex-perience. The Wall Street Journal recently coined Kansas City as “Silicon Prairie” and believes that the first Google Fiber network “will likely bolster cloud-based technolo-gies 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 under-stand 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 Perform-ing Arts opened its doors. The $326 million dollar center was paid for through all private donations and sits in the heart of the Kan-sas City Crossroads Arts District, which has become a hub for artists, digital media and advertising firms, filmmakers, and forward-thinking 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.
F O l l O w J a s O n g r i l l O n T w i T T e r twitter.com/jasongrill
KC’s Crossroads Art and Design District is a hot-bed for entrepreneurs and tech startups.
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.
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.”
a y e a r i n r e v i e w : F u n d i n g O u r T O m O r r O w 21
Kansas City has a legacy of artistic and en-trepreneurial 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 na-tional hub for arts and innovation.
Sparked by unbounded energy and ingenu-ity, KC has the fourth largest concentration of graphic designers, and the seventh larg-est concentration of visual artists. Undergo-ing a major arts renaissance, the KC region is a mashup of American creativity – the intersection of artistry and technology. For more visit kCCreativeCrossroads.com.
KCnext – The Technology Council of Greater Kansas City serves as the regional advocate for Kansas City’s technology industry, sup-porting more than 80 tech council mem-bers, and growing.
KCnext is committed to growing the exist-ing base of technology firms, recruiting and attracting technology companies, aggregat-ing and promoting KC’s regional IT assets and providing peer interaction and industry news.
By focusing on key industry priorities, KC-next works to connect, promote and sup-port the KC region’s tech industry. For more information, visit kCnext.com.
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.
no.16no.7
no.10top10
top7
top
top4no.20
best Cities for JobsNew GeoGraphy, may 2012
recent College gradsForbes.com, march 2012
one of America's techiest CitiesTravel + leisure, Jan. 2012
tech industry Job growth iT world, march 2012
innovative Center for information technology 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
KANSAS CITY: on the rise
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stAte tAx InCentIve nAMe MAx CredIt suMMAry trAnsFer
Arizona small business capital investment Tax incentive program
35% Amount inVested investment of at least $25,000 cash or cash equivalentFinAnCiAl 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.
no
Arkansas equity investment Tax credit incentive program
33.3% Amount inVested no restrictionFinAnCiAl reQuirement no restrictionperCent The equity investment tax credit 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.
15% 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 invest-ment) 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
hawaii hawaii high Technology business investment Tax credit
100% 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
indiana indiana venture capital investment Tax credit
20% Amount inVested no restrictionFinAnCiAl reQuirement has had 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 chapterperCent The lesser of the total amount of qualified investment capital provided to the qualified indiana business in the calendar year, multi-plied by 20% or $500,000.
no
kansas Kansas angel investor Tax credit
50% Amount inVested no restrictionFinAnCiAl reQuirement noneperCent a tax credit shall be equal to the lessor of $50,000 or 50% of an angel investor’s Qualified cash investment in a single business.
yes
kentucky Kentucky investment Fund Tax credit
40% Amount inVested no restrictionFinAnCiAl reQuirement The company’s net worth is less than $5 million (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 millionperCent The Kentucky investment Fund act (KiFa) offers a 40% tax credit to certain personal and corporate investors in approved invest-ment funds.
yes
Government Incentives for Angel Investorstax Credits
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 Angel-friendly incentives —read on to see if you qualify for any of them.
a y e a r i n r e v i e w : F u n d i n g O u r T O m O r r O w 23
stAte tAx InCentIve nAMe MAx CredIt suMMAry trAnsFer
maine maine seed capital Tax credit
60% Amount inVested no restrictionFinAnCiAl reQuirement annual gross 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 invest-ment is in a business located in a certain high-unemployment area).
50% Amount inVested individual or any entity who invests at least $25,000 in a Qualified maryland biotechnology company.FinAnCiAl reQuirement noneperCent provides income tax credits equal to 50% of an eligible in-vestment for investors in qualified maryland biotechnology compa-nies.
no
minnesota seed capital investment credit
45% Amount inVested no restrictionsFinAnCiAl reQuirement has its principal office in a border city (brecken-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 pro-jected 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.
no
minnesota angel investment Tax credit
25% Amount inVested The minimum qualifying investment is $10,000 (in-vestors) 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 per-cent 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
new Jersey high Technology investment Tax credit
10% Amount inVested no restrictionFinAnCiAl reQuirement none. however, 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.
unknown
new mexico
angel investment Tax credit
25% Amount inVested no restrictionFinAnCiAl reQuirement a qualified 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 investmentperCent 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.
no
new york Qualified emerging Technology companies
20% Amount inVested noneFinAnCiAl reQuirement Total 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 3102-e to qualify for the Qualified emerging Technology company capital Tax credit (QeTc)perCent 10% of qualified investments, provided the taxpayer certi-fies 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).
no
north Carolina
north carolina Qualified business investment Tax credit
25% Amount inVested ?FinAnCiAl reQuirement ?perCent The credit is 25 % of the amount you invested or $50,000, whichever is less.
no
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tAx CredIts
24 a n g e l c a p i T a l g r O u p
stAte tAx InCentIve nAMe MAx CredIt suMMAry trAnsFer
north dakota
north dakota seed capital investment Tax credit
45% Amount inVested no restrictionFinAnCiAl reQuirement must meet north dakota primary sector certi-fication and must bring in revenue from outside the state. maximum aggregate amount of qualified investment in any one qualified ven-ture is limited to $500,000perCent 45% tax credit of the amount invested up to $112,500
no
ohio Ohio Technology investment Tax credit
30% Amount inVested The Ohio entity can receive up to $1.5m in invest-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 invest-ing 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.
no
oklahoma Oklahoma small business capital credit
30% Amount inVested ?FinAnCiAl reQuirement capitalization of the qualified business capital company must be at least $1m.perCent 20% 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)
no
oregon university venture development Fund Tax credit
60% Amount inVested no restricitonFinAnCiAl reQuirement not applicable since this tax credit is for invest-ments in universities and not companiesperCent 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.
no
rhode island
rhode island innovation Tax credit
50% Amount inVested no restrictionsFinAnCiAl reQuirement has annual gross revenues of less than $1m in the prior two calendar years.perCent 50% credit on eligible investments, with maximum tax credit of $100,000.
no
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 invest-ments made during the taxable year.
no
wisconsin wisconsin angel investor Tax credit
25% Amount inVested have not received more than $1m in investments that qualify for angel investment tax credits.have not received ag-gregate 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).
no
The above tax Credits table is a modification of the table put together by The connecticut Technology council. data sources include each state’s govern-ment 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: [email protected]
tAx CredIts
a y e a r i n r e v i e w : F u n d i n g O u r T O m O r r O w 25
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 de-livery 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 in-strument for spinal surgery enabling multiple level micro discectomy procedures on an am-bulatory basis.
how did Funding ChAnge your Com-pAny? 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.
how do you think ACCess to CApitAl Could Be mAde eAsier For Future en-trepreneurs? In this field most entrepre-neurs are technology driven and challenged
with positioning their endeavors for fund rais-ing. Fund raising from this viewpoint is a nec-essary evil. Assistance from major corporation interested in the technology as a future mar-ketable product for them could significantly streamline the process.
whAt AdViCe do you hAVe For entre-preneurs 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/in-centive 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 in-Vestor 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.
Profile no. 2
CompAny nAme InQ Biosciences Corp.
Ceo nAme Russell K. Garlick
CApitAl rAised to dAte $4,809.000
yeAr Founded 2008
whAt does your CompAny do? InQ Bio-sciences supplies leading edge cell research instruments that bring a higher level of capa-bility, productivity, and information technol-ogy 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 biol-ogy, 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 simi-lar to what they would experience were they still inside the human body.
how did Funding ChAnge your Com-pAny? 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 in-terests lie after revenues have begun, so the organized angel groups that funded us have been essential.
A n g e l i n v e s t i n g i n r e A l t i m e
26 a n g e l c a p i T a l g r O u p
how do you think ACCess to CApitAl Could Be mAde eAsier For Future en-trepreneurs? The “organized” angel groups are a definite step up from the random angels. The organized groups need to get better at per-forming diligence in a common way so that deals can be syndicated more easily among them.
whAt AdViCe do you hAVe For entre-preneurs rAising money? Learn to tell your market demand and business value cre-ation 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 real-world analogies to help with the understanding.
Are you going to BeCome An Angel in-Vestor when you exit? why or why not? All of us on the leadership team at In-Qbio have been angel investors for a long time. We expect InQbio’s success to expand our abil-ity 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 Deci-sion Support (CDS) system. Medloom uses several patent-pending Health IT technolo-gies 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 AI-driven risk patterns to all patient records in the EMR to identify patients at risk.
how did Funding ChAnge your Com-pAny? ACG funding enabled Lead Horse to bolster its IP portfolio, expanding patent pro-tection to several nations around the globe.
how do you think ACCess to CApitAl Could Be mAde eAsier For Future en-trepreneurs? Better attendance/ angel turn-out at each of our in-person presenta-tions would likely have increased the final
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 an-gel investment group than ACG. They provid-ed phenomenal support and professionalism. And they were pleasant to work with!
whAt AdViCe do you hAVe For entre-preneurs rAising money? Get a good law firm—one experienced in keeping start-ups squeaky clean—to ensure that all of your ef-forts are SEC-compliant.
Are you going to BeCome An Angel in-Vestor when you exit? why or why not? I’m already registered as an SEC-ac-credited investor and intend to stay that way. Angel investment is how the best ideas be-come reality.
Profile no. 4
CompAny nAme TrakLok Corporation
Ceo nAme Thomas Mann
CApitAl rAised to dAte $4.6M
yeAr Founded 2008
whAt does your CompAny do? TrakLok Corporation is a product and service compa-ny deploying a solution to secure and globally track shipping containers and cargo.
how did Funding ChAnge your Com-pAny? Funding allowed us to complete the Product design process for our Locking Sys-tem and our Lock Portal.
whAt AdViCe do you hAVe For entre-preneurs 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 in-Vestor 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
CompAny nAme KC Biomedix, Inc
Ceo nAme Mike Peck
CApitAl rAised to dAte $9.3M
yeAr Founded 2006
whAt does your CompAny do? KCBX is a commercial stage medical device company developing and selling products that address the overwhelming problem of feeding incom-petency in infants and new borns.
how did Funding ChAnge your Com-pAny? The most recent round of funding allowed the company to implement an agree-ment 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 en-trepreneurs? Somehow bringing angel investors and early stage and start-up com-panies together more efficiently. A sweet spot is $1-4 million rounds. New companies need the risk capital that angel investors are will-ing to invest but it is difficult for such small companies to deal with the number of angel investors needed to raise that amount of capi-tal. Currently companies are forced to go to venture firms willing to provide seed capital which denies good opportunities to angel in-vestors.
whAt AdViCe do you hAVe For entre-preneurs rAising money? Persistence.
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, global-leading software technology firm that pro-vides comprehensive 5D SMART™ technology solutions to government agencies, master de-velopers 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 Com-pAny? During our Seed Round, Screampoint developed our Cloud-based software develop-ment, city-as-a-platform product, 5D SMART City™. As we entered a Series A Round, we re-
our portFolIo CoMpAnIes
a y e a r i n r e v i e w : F u n d i n g O u r T O m O r r O w 27
geogrAphyportFolIoof our
the
quired funding to develop SMART Apps that work with the 5D SMART City platform, fur-ther 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 en-trepreneurs? 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 entre-preneurs 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, pro-viding transparency and delivering what you say will achieve are the cornerstones to a suc-cessful venture.
Are you going to BeCome An Angel in-Vestor when you exit? why or why not? I believe the majority of the leadership at Screampoint would become Angel Inves-tors 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
CApitAl rAised to dAte $365,000
yeAr Founded 2009
whAt does your CompAny do? Peare-scope 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 en-trepreneurs? Crowd-sourced funding.
whAt AdViCe do you hAVe For entre-preneurs 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 in-Vestor when you exit? why or why not? Yes, with the experience of a successful exit, I’d like to be able to contribute to mul-tiple 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 process-ing and text analysis. Over the past 7 years, they have developed a multi-patented text analysis platform that has been road tested
in real-world commercial applications. They have worked with hundreds of customers over the past few years and some of the larg-est 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 chil-dren 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 predic-tors of success in each job.
With this, employers substantially increase the likelihood of placing the right person in the right job. Candidates increase the likeli-hood of securing a job and career that they will enjoy and where they will perform.
6
4 1
9
8
512
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2
7
11
13
10
1 Optivia Winston Salem, nC2 InQBio huntsville, Al3 Lead Horse Junction City, KC4 Traklok Knoxville, tn5 KC Bio Kansas City, Mo6 ScreamPoint Menlo Park, CA7 Pearescope new york, ny
8 Sun Pro-Tec Systems Memphis, tn9 Signix Chattanooga, tn10 Facebook Menlo Park, CA11 OpenAmplify Anapolis, MD12 AB Pathfinder olathe, KS13 Matchpoint Careers new york, ny
28 a n g e l c a p i T a l g r O u p
Equity Structures for High-Growth Companies
preferreddeal structures
Revenue-model companies, by con-trast, are typically structured for the founders and other owners to realize wealth by generating revenue and op-erating at a profit to be distributed pe-riodically. Although these companies may have substantial growth opportu-nities, 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 ar-ticle will use a corporation model, with shares of stock of various classes, rather
than a limited liability company (LLC) model. However, LLC “units” (rather than using LLC percentage interests) having essentially the same character-istics as corporate stock can be created in an LLC operating agreement. Addi-tionally, these same concepts apply re-gardless 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 com-pany’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 ex-change 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 collec-tively representing 100% ownership. Any single stockholder’s equity owner-
can generally be categorized as either
growth-model companies or revenue-model companies. growth-model companies are characterized by de-
veloping 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
a y e a r i n r e v i e w : F u n d i n g O u r T O m O r r O w 29
ship percentage is equal to the number of issued and outstanding shares regis-tered in the stockholder’s name, divid-ed by the total number of all the issued and outstanding shares.
The “par value” of a share of stock rep-resents 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 com-pany 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 in-come to the stockholder.
When the company has received at least the par value of shares to be issued, and the shares have been properly repre-sented 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 is-sued, fully paid and non-assessable.” When a stockholder owns validly is-sued, fully paid and non-assessable shares, then the stockholder cannot be required to contribute additional capi-tal to the company (unless the stock-holder has agreed to a contractual re-quirement 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 di-rectors and on certain substantial cor-porate 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 stock-holder’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 com-pany’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 com-pany does not have any stockholder rights (such as voting) for shares held in treasury. However, this affects how the shares are reflected on the compa-ny’s balance sheet and also would per-mit 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 classifi-cations of shares are “common stock” and “preferred stock.”
Common Stock. Common stock is the foundation of a company’s equity struc-ture. It is the last class of stock (or lowest in order of priority) to receive any divi-dends or other distributions to the stock-holders, 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 avail-able for distribution after satisfying all prior rights, so that common stock may also represent the highest opportunity for upside return. Consequently, com-mon 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 com-mon 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 com-pany’s upside return but no opportuni-ty 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 deci-sions requiring stockholder votes.
A frequent use of classified common stock is to create classes of directors that are elected by the correspond-ing 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 direc-tors would be elected by the holders of class B common stock. This would mean that the class A stockholders con-trol 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 tra-ditional financing. This indebtedness is often accompanied by a right of conver-sion into a class of the company’s equi-ty securities, based on a conversion ra-tio and an implied company valuation. Bridge loan financing, as described be-low, 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 securi-ties at a specified price, and sometimes upon the occurrence of a specified event (e.g. a subsequent round of equi-ty financing, or a liquidity event). War-rants may be “attached to” and accom-pany convertible debt securities or any equity securities. Additionally, financial
preFerred deAl struCture
30 a n g e l c a p i T a l g r O u p
preFerred deAl struCture
preferred stock
» Preferred stock may receive a stated rate of return, ex-pressed 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.
» Preferred may receive preferential distributions in a liq-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.
» “Participating” preferred stock receives both a liquidation preference in priority to common stock, and then also partici-pates in any liquidating distributions to the common stock.
» “Convertible” preferred stock allows preferred stockhold-ers to choose between the preferential returns to preferred stock, or the potential unlimited upside returns to com-mon 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.
» “Redeemable” preferred stock permits the company to buy back or redeem the preferred stock by paying the pre-ferred 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 stock-holder 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.
» Special voting rights, in which preferred stock gets more votes than one-vote-per-share, or votes for a special class of directors (similar to class A and class B directors as de-scribed above).
» The company may establish “covenants” with the pre-ferred stockholders, so that certain events are prohibited (“negative covenants”) without their approval (e.g. sell-ing 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 pro-tected 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 pre-investment valuation.
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 divi-
dends 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:
All of the foregoing terms and conditions of common and preferred stock are usually established in the company’s articles of incor-
poration. 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 clas-
sified 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 sepa-
rately with each subsequent group of investors, depending on the facts and circumstances as then exist and the specific investment
requirements of those investor groups.
a y e a r i n r e v i e w : F u n d i n g O u r T O m O r r O w 31
advisors who assist the company in its fund-raising strategies may obtain war-rants as a part of their fee structure.
eQuity struCture exAmple
Here is an example of how a high-growth 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 des-ignated common stock, and further classified as:
» 1,000,000 shares of class A com-mon stock (voting)
» 3,500,000 shares of class B com-mon 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 compa-ny’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 pre-existing intellectual property) in ex-change for class A common stock. Their initial capital contributions would indi-cate a nominal or minimal initial com-pany 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 ty-ing the founders to each other in a distinctive way by having them all own the same class of shares. The found-ers would establish the initial board of directors, often consisting of all the founding stockholders.
Early Stage Investors. This is the fund-ing stage that enables the founders to build the company beyond their own limited financial resources. The inves-tors 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 con-ditions 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 found-ers, often referred to as “friends and family” investors. Importantly, once the company begins to obtain investor funding outside of the founding stock-holder group, the company must com-ply with important federal and state se-curities law requirements applicable to the offer and sale of securities.
The early stage investors may receive class B common stock for their invest-ments, but sometimes angel investors will require a class of preferred shares to be established for their investment. This investment is based on a stron-ger 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 valu-ation. Thus, this round may be propor-tionately 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 clas-sified 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, re-quiring a substantial amount of plan-ning and potentially extended efforts to identify prospective investors and ne-gotiate their investment transactions. When this is the case, the company may require an intermediate financ-ing, between the early stage and sec-ond stage funding, in order to “bridge” the company’s capital requirements between these two investment rounds. This bridge financing is often struc-tured 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 moti-vate the company to be diligent in seek-ing 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 (in-cluding price) to be offered to those an-ticipated 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 in-debtedness. This bridge loan financing is often referred to as “convertible sub-ordinated debt.” Many of the terms and conditions of the convertible subordi-nated notes will be similar to the terms and conditions anticipated for the sec-ond 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 fi-nancing. Venture capital and other pri-vate equity firms are often the source of this financing. Second stage fund-ing 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 re-quired to provide for the company’s
32 a n g e l c a p i T a l g r O u p
on-going capital requirements vary as widely as the companies that may be formed, and often depend on the spe-cific industry in which the company is pursuing its opportunities. For exam-ple, a technology company may pur-sue 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 com-pany’s success, without whom the com-
pany would be likely to fail. The concept is that, if these key individuals have a stake in the company’s upside, by shar-ing in any potential increase in the value of the company’s equity ownership, they will be more highly motivated to con-tribute 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 avail-able 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 il-lustrated by this example provides for class C non-voting common stock as an alternative. These shares can be award-ed as direct stock grants or as stock op-tions priced to a current company valu-ation. The concept is that the insiders
who obtain equity incentives should not be in a position to also vote on the board members who are their ultimate super-visors, and on significant corporate de-cisions 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 com-mon 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 sub-ject to forfeiture or repurchase if the in-dividual leaves the company. Also, the grants or options are often accompa-nied by non-disclosure and non-com-pete requirements and an obligation to assign to the company all proprietary rights pertaining to the company’s business. These arrangements may
have significant tax consequences to both the company and the individuals receiving the grants or options.
This equity structure example is mere-ly one illustration of how a high growth company may structure its equity own-ership. 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 for-mation, a company not only anticipates the kinds of arrangements prospective investors may require, but it can also establish the equity framework it pre-fers at a time when the company is not yet subject to the control of its eventual investors. If the equity plan is well-structured 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.
"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 pre-fers at a time when the company is not yet subject to the control of its eventual investors."
About the Authorphilip 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 ser-vices 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, man-agement, investors, etc.), acquiring, protecting and licensing intellectual property assets, securing capital resources through financing transactions (debt, eq-uity, 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 knowledge-base 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 Sci-ences 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 busi-ness plans. As an entrepreneur-In-residence for the uMKc Institute for entrepreneurship and Innovation at the Henry W. Bloch School of Management, Philip inter-acts 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 de-veloping practical, solutions-based reference materials to address start-up company challenges.
Philip received his law degree from Vanderbilt universi-ty 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.
preFerred deAl struCture
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