Television makes angel investing look simple and straightforward. On shows like Shark Tank, small businesses or startups pitch their minimum viable product (MVP) or service to a panel of wealthy angel investors. Invariably, at least one business picks up an angel, gaining an infusion of capital for a percentage of stock and profits.
In real life, negotiations take weeks or months, and lawyers complete mounds of legal documents to cement the deal. If you want to enter the field of angel investing and help develop businesses in Massachusetts, work with business attorneys in Boston to develop the following documents for each investment.
- Term sheet
- Stock purchase agreement
- Disclosure schedule, also called Schedule of Exceptions
- Investor rights agreement, also called Registration Rights Agreement
- Voting Agreement
- Right of First Refusal and Co-Sale Agreement
- Certificate of Incorporation or Certificate of Amendment
- Legal opinion
- Accredited Investor Questionnaire or Certification
- Signature pages.
As Nerd Wallet explains, an angel investment represents the purchase of preferred stock in the company without a public listing of the stock. A business can take on an angel investor before going public, so the U.S. federal government requires extensive legal documentation to satisfy compliance with the regulations of the U.S. Securities and Exchange Commission (SEC).
What do the legal documents do?
Your attorney might refer to the documents in this packet as legal instruments. Each document does a different job to achieve the goal of investing in the fledgling company. Let’s consider what each instrument accomplishes.
According to Seraf, the term sheet may take a simple form, such as a memorandum of understanding. This memo summarizes the deal’s terms, but unless the document specifically states it consists of a legally binding agreement, it does not. Think of it as an executive summary of the extensive contractual paperwork.
An angel investment agreement includes a Stock Purchase Agreement (SPA). If the business has yet to go public, the SPA creates the preferred stock shares that the investment will divide between the company’s founders and the investor. It documents the sales transaction and specifies the key terms of the sale, plus risks.
Although disclosure schedules comprise part of the SPA, lawyers prepare them separately from the SPA. It contains vital company data and reference information, including a statement of veracity regarding existing contracts, outstanding stock shares, and litigation.
The Investor Rights Agreement (IRA) documents the rights and privileges of the stockholders. Typically, it guarantees the stockholder’s right to have their stock registered with the SEC when the company makes its initial public offering (IPO). This legal instrument also provides the stockholder the right to management and financial reports and the right to participate in future funding rounds. It sometimes contains the establishing text of the company’s board of directors and its original members.
The Voting Agreement (VA) stipulates that signing stockholders must vote together for the good of the company in relationship to board changes, mergers, liquidations, etc. It usually contains a “drag along right” that guarantees that the minority hold-out voters will bend to the “will of the majority” to approve acquisitions, liquidations, or mergers. This legal instrument also establishes and defines the voting proxy mechanism.
The Right of First Refusal (ROFR) and Co-Sale Agreement (CSA) give the company the option to purchase any proposed preferred shares from an existing stockholder, so no new shareholders can enter the company. If the business does not purchase the preferred stock, then the secondary right to purchase goes to the other existing shareholders. This document also protects other shareholders from third-party sales, so a stockholder could exist in the company.
Including the Certificate of Incorporation ensures the documentation of the new class of preferred stock gets recorded properly. Creation of this includes all of the rights that go with the stock, which other documents also detail. The company’s legal counsel provides a legal opinion that the company operates with a good reputation and enters into the legal transaction in good standing. It includes financial details attesting to these opinions.
The angel investor also contributes a legal instrument to the agreement packet – the Accredited Investor Questionnaire and Certification. The SEC requires this certification to document that the investor has the financial means to withstand a loss in this early-stage investment. The form documents the experience and sophistication of the investor.
Finally, most contracts close with the signature pages, on which each founder and investor sign their name. The attorneys may have a notary public stamp the document to show its date of legal signing.
Entering a Company as an Angel Investor
TV shows make it look easy to start investing as an angel, but the reality differs. Contact an experienced Massachusetts business law attorney before hearing pitches or attending any development meetings. You will need to first complete your accredited investor paperwork before you can participate and your lawyer can help you with that.