Raising capital is a pivotal step for many startups in their early stages seeking to accelerate growth using external capital, rather than grow organically. For many founders, approaching a funding round can feel daunting, even before deciding on strategy between raising from angel investors or venture capital (VC). Everyone begins from a standing start, and if you don’t have an existing investor network, it is a challenge!

Angel rounds are a popular choice for early stage startups due to their relatively flexible, founder-friendly nature, as well as the added value of strategic angels. However, there are crucial legal considerations to keep in mind.

This blog post will help early-stage founders understand the legal must-knows when raising an angel round, ensuring you have a smooth and successful fundraising process.

Understanding Angel Investors

An angel investor can be any individual who is willing and able to invest in your business. Angel investors are typically high-net-worth individuals who provide capital to startups in exchange for equity or convertible debt. They will often have a portfolio of prior investments and so in those cases will have been through investment processes before. They will often offer not only financial support but also mentorship and valuable industry connections - of course this depends on the individual though.

Key Legal and Strategic Considerations

1. SEIS and EIS Tax Reliefs

UK angel investors will potentially be able to benefit from SEIS and EIS tax relief schemes for their investments in your company, making the investment more enticing and affordable.

Most startups apply for SEIS and EIS Advanced Assurance ahead of their funding round to confirm their eligibility for the scheme. Contact us directly for support with your application.

2. Single Close or Advanced Subscriptions

In a single close round, all or the majority of investors invest at the same time, and you issue the shares immediately after the investor transfers you their money. This is typically when you have most or all investors ready to invest simultaneously and you can close the round there and then.

In an ASA (applying SEIS and EIS rules), investors invest sporadically over a 6 month period and you issue the shares at the end of or before the end of 6 months once all investors have invested. This is typical for when you have only one or a minority of investors required to reach your round target, but you want to start taking investment money now rather than waiting.

3. Term Sheet and Shareholder Agreement

• Term Sheet: This is a non-binding agreement outlining the basic terms and conditions of the investment. It includes details on valuation, investment amount, type of shares, and investor rights. This is typically the first document you would share with an investor once they confirm their readiness to invest.

• Shareholders Agreement: This legally binding document defines the relationship between the company and its shareholders, detailing rights, obligations, and protections for both parties. For a single-close round, the shareholders agreement is signed at the time of the investment. For an ASA round, the shareholders agreement is signed when all of the ASA investments convert to shares at the end of the round.

4. Types of Share

Ordinary shares only: In an angel round, the most common thing to do is to offer investors ordinary shares, being the same type of shares the founders have, with no special preferences or rights, such as liquidation preferences or anti-dilution rights. These are generally required by VC investors, but the market standard for angel investments is that the angels receive ordinary shares.

5. Founder Equity Dilution

Dilution: Issuing new shares to angel investors will dilute the ownership percentage of existing shareholders proportionately. It's important to understand the impact of dilution on your control and ownership at the end of the round. We can help you model future equity dilution scenarios​​. You can read more on share dilution for startup founders here and reach us directly here.

6. Board and Shareholder Consents

• Shareholder Consent: Pre-emption rights (aka pro-rata rights) allow existing shareholders to maintain their proportional ownership and not be diluted in a round, by participating in it (i.e. investing in it). Before executing a funding round, you should either offer pre-emption rights to existing shareholders or request that they waive pre-emption rights so that the round can go ahead.

• Board Consent: The directors of the company should approve the funding round at a board meeting and sign a set of board minutes as a record of the approval.

Sophisticated investors will not invest until they know their investment has been approved by both the shareholders and the board.

7. Investor Consent Rights

Angel investors may require consent rights to protect their investment. These rights give investors a say in significant company decisions after the investment is made, such as issuing new shares, selling the company, changing the nature of the company’s business or altering the company's articles of association​​.

These rights should be carefully negotiated to ensure the company isn’t prevented from taking day-to-day decisions without bureaucracy.

8. Founder Vesting

Vesting schedules ensure that founders earn their equity over time, aligning their interests with the company's long-term success. This is a common requirement from investors to ensure founders remain committed to the business​​, especially where the presence of a particular founder or founders was a key driver for an investor’s decision to invest in the first place.

9. Alternatives to Advanced Subscription Agreements (ASAs)

• Convertible Notes: These are short-term debt instruments (i.e. loan documents) that convert into equity upon a future financing round. They often include a discount rate or valuation cap for when the loan converts to shares. These operate similarly to an ASA, except that unlike with an ASA, there may be some scenarios where the debt is repayable, rather than convertible into equity.

• SAFEs (Simple Agreement for Future Equity): The SAFE is the US version of an ASA. SAFEs convert into equity at a future date in the same way as an ASA.

Best Practices for Founders

• Seek Legal Advice: Engage a lawyer experienced in startup financing to help navigate the complexities of term sheets, shareholders agreements, and other legal documents. Accelerate Law specialise in angel funding rounds.

• Negotiate Terms: Understand the terms being offered and negotiate where possible. Focus on key terms that impact control and ownership, such as board seats, voting rights, and anti-dilution provisions.

• Prepare Thoroughly: Have a clear business plan, financial projections, and a solid pitch to attract the right investors. Transparency and preparedness can help build trust with potential angel investors.

Raising an angel round can provide the necessary capital and strategic support to propel your startup forward. By understanding and addressing the key legal considerations, early-stage founders can navigate the fundraising process more effectively and set their companies up for long-term success.

Accelerate Law provides flexible strategic and legal support to startups end-to-end through angel investment rounds and VC funding rounds, which includes supporting with SEIS and EIS matters, flexible funding for example through Advanced Subscription Agreements, and drafting and negotiating investment terms from term sheets through to completion. Accelerate Law also specialise in EMI Schemes for startups. Contact us here to find out more.