Angel investment is often the best (or only) way for a startup to achieve the investment it needs to grow. Angel investors invest cash in the startup in exchange for shares in the business. One of the main concerns for founders seeking angel investment is not only the size of the equity stake they are giving up, but also the level of control they will have to relinquish in the company.
In this article, we are going to look at the various ways in which founders can protect their position in the company before onboarding an angel investor.
- Why would an angel investor want significant control?
- How much equity should you give away?
- How will my control in the company change?
- Control at Board Level
- Control at Shareholder Level
- Control at Investor Level
- Control at Employee Level
- Next Steps
Why would an angel investor want significant control?
There may be a number of reasons why an angel investor would want significant control but the most likely reason is to be able to mitigate the risk of losing their investment. If this is the case, then you, as a founder will need to work with the angel investor and your legal teams to find a balance of control which you are both comfortable with. If you can’t achieve this, it may be time to look for another investor. It is unlikely that experienced angel investors would ask for significant control in any case as they would have already assessed the risk before offering to invest in your business.
How much equity should you give away?
The answer to this will depend very much on the individual circumstances of the founder, the business and the investor. The amount of equity you give away will always be a matter for negotiation with the investor. As a broad guideline, most founders will look to give away somewhere between 10-20% of their share capital. You will want to ensure that you do not give away too much equity early on as you will want to retain a decent percentage in the company on an exit and you will be diluted in future investment rounds.
How will my control in the company change?
This will depend on the amount of equity you have exchanged for the investment. As a general principle, the more shares or equity you own, the more power you have as a shareholder. Shareholder power is exercised by the majority so if you own more than 50% of the shares in the company then you can take most decisions apart from a few corporate actions (such as changing the company’s articles of association) which require a 75% majority. In reality, most routine decisions are taken by the directors rather than the shareholders and so making sure you have control on the board of directors is essential. This is why the specific provisions in the investment documents (including shareholders’ agreements and articles of association) are so important.
Control at Board Level
As a founder, you will want to ensure that you retain control of the day to day running of the business. You will almost certainly be a director of the company already and will need to include provisions that give you the right to continue to be a director (or appoint a representative) – you will usually be referred to in the investment documents as a ‘founder’ director. This will allow you to stay in the driving seat of the business and continue to have full access to all information.
The angel investor may also want to have the right to be a director or appoint a director to the board or require an observer position. The investment documents will typically refer to this director as the ‘investor’ director. As a founder, you will want to make sure you have the right to be consulted prior to the appointment or replacement of an investor director.
In most private limited companies, each director has one vote at a board meeting and board decisions (resolutions) are passed by majority vote. This means that as a founder you will want the right to appoint yourself and other directors to enable you to have the majority vote on the board. If this is the case, the investor will want certain key decisions to be subject to the consent of the investor director. As a founder, you should ensure that any such decisions are limited to high-level decisions only to avoid any constraints on the daily running of the business. You will also want your attendance to be a requirement at each board meeting in order for it to be quorate.
Control at Shareholder Level
A list of matters can be included in the investment documents which will set out material decisions requiring the consent of a higher shareholding percentage than would normally be required or even the unanimous consent of the shareholders. Ideally you want to steer clear of any matters which are subject to unanimous consent, given that as the company progresses, some investors become passive and non-responsive. These are usually referred to as reserved matters or matters requiring shareholder consent. They can cover a whole range of actions in the business such as appointing and replacing directors, taking on loans, starting litigation on behalf of the company and making changes to constitutional documents.
You may think that this is more important from the investor’s point of view especially if you intend on keeping the majority of the shares in the business. You may find yourself in a position where your shareholding is reduced, however, as you secure further investments down the line and if this happens you will want to ensure that these protections are already in place. There are certain ways to manage the consents required by introducing deemed consent in certain circumstances.
If you continue to be the majority shareholder post-investment and wish to sell your business (and weren’t restricted in doing so by any other provisions of the investment documents), a drag right would allow you to force the other shareholders into selling their shares to a prospective purchaser on the same offer terms. This is a useful provision to have as the majority of the shareholders are not restrained by minority shareholders in the event of an exit.
As a founder you may want to consider including rights to make transfers to close family members for personal or tax reasons, without seeking the consent of the other directors or shareholders. Most investors require this right. Such rights can be included in the investment documents and is something our team would discuss with you when drafting the documents.
Control at Investor Level
There will be certain decisions (such as the reserved matters) which will require the consent of the investors. Most angel investors are actively involved in the business and so seeking consent shouldn’t be an issue.
For situations where the angel investor is more passive or operates mainly through an appointed investor director, you may need to consider certain protections as a founder to keep the business running smoothly. For example, permitting the investor director to give consent rather than having to wait for investor consent or even including a deemed consent if the investor fails to respond to the consent request after a certain period of time.
If there are multiple investors, consider appointing a lead investor in the documents to act on behalf of all of the investors or introduce a threshold where the consent can be obtained from the majority of the investors.
Control at Employee Level
As a founder, you are likely to have to enter into an employment agreement with the company as part of the investment deal. This will typically contain restrictive covenants which may prevent you from being involved in a competing business and from taking employees and customers once you have left the business. Our corporate team can assist you in reviewing these covenants and ensuring they are not unnecessarily restrictive if you did want to start a similar business in the future.
Employee shareholders are often forced to give up some or all of their shares if they leave the company for any reason and so you should be mindful of such provisions. There may also be leaver provisions which specifies the price which will be paid for your shares depending on the circumstances in which you are leaving (‘good’ leaver or ‘bad’ leaver). This is often the most heavily negotiated term in investment documents. This is something which can be discussed in more detail with the corporate team when reviewing the investment and employment documents.
Onboarding an angel investor to your business is an exciting time but it is also a crucial turning point for your business. You don’t want to get caught up with the excitement of the investment without first considering key protections in the investment documents, such as those we have discussed above.
Find out more about angel investment in our article The pros and cons of using an angel investor to fund your business. If you're looking at raising angel investment soon, you'll also want to read our How to raise angel investment guide, including what angel investors look for and how to prepare before a raise.
Giving up equity in your company does not have to result in you losing control of your business. Our experienced legal team will be happy to talk you through all of the details and options for keeping control and the protective provisions which can be put in place to achieve this. Get in touch on 0800 689 1700 or fill out the short enquiry form below and one of our team will be in contact.