Business Angels as investors: organizational and legal aspects

Andriichuk Liza, 111-i, KNEU

To begin with, who is a business angel? Is that actually legal and if yes, then which documents are needed? What about business angels in Ukraine?

Business angel is a wealthy, private investor, who provide capital for young companies at the start-up phase or during a level of expansion. Unlike venture capitalists – whose money is often pooled by investment firms – business angels usually invest their own funds.

Completing an Angel investment requires legal processes to clarify and confirm the deal terms and protect all parties concerned. Angel investors are advised to seek legal advice from lawyers who are experienced in doing investment transactions of this size and nature, notably incorporating the EIS and SEIS schemes.

So what about key documents that are needed?

Once the investment terms have been agreed, these should be integrated into the main legal documents which will typically comprise those set out below:

  1. Term sheet
    The negotiation of a satisfactory term sheet is one of the most critical parts of the process of equity investment. The term sheet should aim for a simple document reflecting the size of the deal.
  2. Investment and Shareholders’ Agreement
    Document sets out the terms of the investment and regulates the relationship of the shareholders once the investment has been completed.
  3. Articles of Association
    Typically, new articles of association are adopted on completion of the funding which will set out the company’s internal regulations and deal with its management and administration.
  4. Disclosure letter
    The disclosure letter often accompanies the documents and sets out disclosures against the warranties contained in the investment and shareholders’ agreement

Legal status of business angels in Ukraine

Law does not define the legal position of domestic business angels, which is the first and the most important reason for hindering the development of private investment in our country. General provisions contained in the Law of Ukraine “On Investment Activity” of 18.09.1991 №1560-XII, which is special in the sphere of investment activity, only in general terms regulate the activity of a business angel, which by its nature is an investment, when such an entity does not refer to investing innovative projects in the above-mentioned normative act.

The main points in determining the legal status of a business angel in Ukraine are to create a legal field of its activity and minimize restrictions; otherwise, even the smallest obstacles in its path may lead to its lack of further desire to invest its own funds in risky innovative projects and only legal protection of “angel” status. , the state’s interest in supporting the development of private investment will be an incentive for investors, both domestic and foreign.

Business angels can be individuals and legal entities, and the latter do not necessarily need to specialize in investment activities.

A business angel to a natural person, both domestic and foreign, is enough to have full civil capacity to invest in an innovative project in the territory of Ukraine. The status of entrepreneur for business angels is optional because, first, their activities are not systematic in nature, and secondly, the procedure for registering an individual as an entrepreneur involves costs for the business angel, both temporal and financial, and thirdly. , the status of the entrepreneur involves taxes and pension contributions, filing a declaration of income – consequences that reduce the attractiveness of investing your own funds business angels into innovative projects. Therefore, the lack of entrepreneur status, and therefore the status of an entity, is not an obstacle for persons who want to become angels of business, as, in fact, the fact of having such status, since the desire of the entrepreneur to invest money can be even more justified on the basis of features of his activity which, in fact, it may require innovative projects.

It should be emphasized that neither the Law of Ukraine “On Investment Activity” of 18.09.1991 №1560-XII, which defines investors of citizens and legal entities of Ukraine and foreign states, nor the Law of Ukraine “On the regime of foreign investment” of 19.03.1996. №93 / 96-BP, which defines foreign entities investments of foreign nationals, do not impose any special requirements for the status of an individual. The Law of Ukraine “On Foreign Investment Regime” of 19.03.1996 №93 / 96-ВР only contains the requirement for full legal capacity of a foreign citizen who acts as an investor.

The question of the legal forms of business angels as legal entities is more interesting. Because there are a number of questions: can there be restrictions have been set for individual organizational forms of legal entities, should the constituent documents provide for the possibility of investing in innovative projects, or can a legal entity not specializing in investment activity finance innovative projects? It should be noted that the domestic legislation for both legal entities of Ukraine and foreign legal entities does not require investment specialization of their activity, which is also applicable to business angels, since the nature of business angels was levelled and possessed when required by such specialization. Only the aforementioned venture capital funds, which, in fact, specialize in the investment activity of innovative projects, would be the place. If the legal entity – an angel – makes a one-time investment in an innovative project, then such activity does not require amendments to the constituent documents and will be considered as a transaction made by authorized persons.

Differences between business angels and venture capitalists

1. A business angel works alone, while venture capitalists are part of a company.

2. They invest different amounts.

Typically, angels invest between $25,000 and $100,000 of their own money, though sometimes they invest more or less. When angels come together in a group, they might average more than $750,000. Venture capitalists, on the other hand, invest an average of $7 million in a company.

3. They have different responsibilities and motivations.

Business angels are primarily there to offer financial support. A venture capitalist looks for a strong product or service that holds strong competitive advantage, a talented management team and a wide potential market.

4. Business angels only invest in early-stage companies.

Business angels specialize in early-stage businesses, funding the late-stage technical development and early market entry. Venture capitalists, on the other hand, invest in early-stage companies and more developed companies, depending on the focus of the venture capital firm. 

5. They differ in due diligence.

Some angels do almost no due diligence – and they are not really bound to, given that all the money is their own. However, it has been shown that when angel investors do at least 20 hours of due diligence, they are five times more likely to see a positive return. Venture capitalists need to do more due diligence, given that they have a fiduciary responsibility to their limited partners. Venture capitalists can spend in excess of $50,000 when it comes to researching their investment prospects.

Business angels in the USA and in the UK

  • United Kingdom

A study by NESTA in 2009 estimated that there were between 4,000 and 6,000 angel investors in the UK with an average investment size of £42,000 per investment. Furthermore, each angel investor on average acquired 8 percent of the venture in the deal with 10 percent of investments accounting for more than 20 percent of the venture. In terms of returns, 35 percent of investments produced returns of between one and five times of the initial investment, whilst 9 percent produced returns of multiples of ten times or more. The mean return, however, was 2.2 times investment in 3.6 years and an approximate internal rate of return of 22 percent gross.

The UK Business Angel market grew in 2009/2010 and, despite recessionary concerns, continues to show signs of growth. In 2013, this dynamic kept going on in the UK as angel investors were named by two-thirds of technology entrepreneurs as a means of funding. By 2015, angel investments had increased throughout the UK, with the average number of investments made by angels at five, compared to 2.5 in 2009. The same report also found an increase in angel investors making impact investments, with 25% of angels saying they had made an impact investment in 2014.

  • United States

Geographically, Silicon Valley dominates United States angel investing, receiving 39% of the $7.5B invested in US-based companies throughout Q2 2011, 3–4 times as much as the total amount invested within New England.  Total investments in 2011 were $22.5 billion, an increase of 12.1 percent over 2010 when investments totalled $20.1 billion. In the United States, angels are generally accredited investors in order to comply with current SEC regulations, although the JOBS Act of 2012 loosened those requirements starting in January 2013. Reaching nearly $23 billion in 2012 in the US, angel investors are not only responsible for funding over 67,000 start-up ventures annually, but their capital also contributed to job growth by helping to finance 274,800 new jobs in 2012. In 2013, 41% of tech sector executives name angel investors as a means of funding.

What Ukrainian government could do to attract the business angels?

Maybe Ukrainian government could pass the law or amend an existing law about «About investment activity» (from 18.09.1991 №1560-XII [1/4]), which is special in the sphere of investment activity and only in general terms regulate the activity of a business angel, which by its nature is an investment. However, such subject does not refer to investing innovative projects in the above-mentioned normative act. Therefore, Verkhovna Rada should include a business angel in this law as a subject of investing into innovative projects.

The main points in determining the legal status of a business angel in Ukraine are to create a legal field of its activity and minimize restrictions; otherwise, even the smallest obstacles in its path may lead to its lack of further desire to invest its own funds in risky innovative projects and only legal protection of “angel” status. , the state’s interest in supporting the development of private investment will be an incentive for investors, both domestic and foreign.

Summary

To sum up, I can say that, unfortunately, in Ukraine law does not define the legal position of domestic business angels so people have to find the way to attract investors themselves.

Therefore, effective investment by business-angels of innovative projects in Ukraine will be possible if a number of factors are combined, in particular:

a) Availability of a potentially profitable innovation project;

b) consolidation at the legislative level of the legal status of business angels, defining his rights, duties, guarantees of activity, establishing privileges and a number of incentives for investment activity;

c) Improving the economic and political situation in Ukraine. The main goal of the domestic legislator should be to create clearly regulated, simplified and stimulating conditions for business angels in Ukraine to continue their effective involvement in the investment sphere.

The European Trade Association for Business Angels

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