Entrepreneurial Gotchas

Recently five members of the Boise Angel Alliance attended the annual meeting of the Northwest chapter of the Angel Capital Association in Seattle. We gather annually to network with other angels and to exchange information on the current state of the art in angel investing.

One of the sessions that I found most interesting was titled “Traps for the Unwary (issues that cost money to fix.)” Presented by KL Gates lawyers, I summarize below their practical advice about several early actions (or lack of action) that are likely to cause issues later. The issues were presented to angels as things to look out for when considering an investment.  But their counsel is equally appropriate for entrepreneurs. 

1.    Mixing open source code with proprietary software.  Open source code is free software which can be downloaded from the internet by anyone and included in their software product.  Whenever you download such software, you are agreeing to a license that governs the use of the software.  The problem is that you probably didn’t read or keep a copy of the license, and it may impact your ability to legally sell your software in which you have embedded the open source code.

Here are two potential problems.  The open source license may require that you make your source code (the human readable software) publically available at no cost.  Or the open source license may permit you to distribute it to others, but only if you don’t charge for it.  Either of these problems can destroy the economic basis for your business.

If you are incorporating open source code in your software, make sure you read and keep a copy of the license to use it, that it does not restrict you from commercializing your product and that you document within your software your use of the open source code.

2.     Failure to maintain proper corporate records.  Your business entity is obligated to keep certain records such as shareholder ledgers, annual meeting minutes and board of directors’ actions.  Many early stage businesses don’t get around to these necessary housekeeping issues.  But someday you will likely want to sell your business or may want to sell stock or borrow money and will be required to produce these records. 

3.     Failure to get assignments of intellectual property rights.  If someone contributed to your product, especially if they were not employees, they may retain some ownership in your IP, even if you paid them for it.  Remember that neighbor who brainstormed with you when you were first starting your company?  When you go to sell your company to Google, he may be back for what he believes to be his share.   All companies should have assignments of intellectual property rights from all contributors, including  founders, employees, board members and independent contractors. 

4.    Not having shareholder agreements.  Shareholder agreements are like pre-nuptial agreements. The time to negotiate the resolution of potential problems is before they occur.  Shareholders must be clear about such things as voting rights, when their approval is needed to borrow money and sell more stock, selection and dismissal of management, and a whole host of other issues. 

Entrepreneurs want to get on with creating and selling a product. They don’t like to spend time and precious money on crafting legal agreements and other details.  But a failure to pay attention to the details at the correct time can result in very expensive corrective action later, or worse may kill a deal because your investor or a purchaser may walk if these issues haven’t been handled correctly in the beginning. Seek competent legal counsel early and equally important, take the time to follow their advice. 

[Update on the Treasure Valley Angel Fund.  This new fund is nearly ready to have its first close of investors and start considering deals. Watch www.treasurevalleyangelfund.com for information.  If you are an accredited investor and would like information on investing in the fund, please send me an email. ]

_____________________________

Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund (www.boiseangelfund.com), and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875. 

Research on angel investing

Gradually we are learning more about the impact of angel investors in our economy and about the behavior of the angels.  Three new research reports have been recently released.  The Angel Resource Institute has published its first Halo™ report (http://www.angelresourceinstitute.org/halo-report/). The Center for Venture Research at the University of New Hampshire published its annual Market Analysis report (http://wsbe.unh.edu/sites/default/files/2011_analysis_report.pdf).  And Silicon Valley law firm Fenwick and West have published their 2011 Seed Financing Survey (http://www.fenwick.com/publications/Pages/Seed-Finance-Survey-2011.aspx).  The Boise Angel Fund contributes data to both the Halo and Center for Venture Research studies.

Here’s a summary of key findings of these reports.

1. The amount of angel investment is increasing. The below data from the Center for Venture Research annual Market Analysis reports show how the market has changed.  It peaked in 2007, and then contracted severely.  While the amounts invested have not yet reached 2007 levels, the number of investors and the number of deals are at all time highs.

Year	2007	2008	2009	2010	2011
Invested	$26.0b	$19.2b	$17.6b	$20.1b	$22.5b
Number of deals	57,120	55,480	57,225	61,900	66,230
Number of investors	258,200	260,500	259,480	265,400	318,480

 

The angel capital  market is nearly as large as the venture capital market.  According to PriceWaterhouse/Moneytree, total venture capital invested last year was $28.4 billion. But these funds were invested in only 3,673 deals, only 5.5% of the deals angel supported.

2. Early-stage deals are increasing. The Center for Venture Research reported that 42% of angel investments were in early stage companies, a significant increase from 31% in the prior year.  The Fenwick & West report says the early stage environment is expanding

3.  Angel investing remains rewarding but risky. The Center for Venture Research annual Market Analyses report about a quarter of the exits each year are due to bankruptcies; but returns on successful investments are in the neighborhood of 25% compounded.  

Year	2007	2008	2009	2010	2011
% of exits due to bankruptcies	27%	26%	40%	22%	24%
Yield on positive exits	28%	26%	23-28%	24-36%	18-28%

4. Not everything happens in California.  The first Halo report tracks angel investing by geography.  Of the dollars invested, 30% occurred in California; 2.3% on the Northwest.  Angel groups are now active all over the country and I believe we will see increasing dollars invested in Idaho and other areas that have not traditionally received early stage angel capital.

5.  Angel capital is relatively easy to secure.  For the last two years the Center for Venture Analysis reports a bit more than 18% of all deals brought to the attention of investors received money. This is atypically high and the CVR expects this rate to drop back to its historical average of 10 to 15%.  By this measure, the Boise Angel Fund is conservative.  About 5% of the deals that have approached the fund have received funding.

6. The Boise Angels’ volumes are typical.  Last year the Boise Angel Fund reviewed 20 deals, including requests for follow on funding.  The medium reviewed by participating groups was 15.  The Boise Angel Fund made three investments, one new and two follow-on.  The median for last year was 3. 

What do all these data tell us?  Angel capital is alive, active and a growing influence throughout the United States.

_____________________________

Dr. Kevin Learned is a counselor at the Idaho Small Business Development Center (www.idahosbdc.org) at Boise State University where he specializes in counseling with entrepreneurs seeking equity capital. He is a member of the Boise Angel Fund, and is a principal in Loon Creek Capital (www.looncreekcapital.com), which assists angels in forming angel funds. He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875.