Treasure Valley Angel Fund -- A Lesson in Raising Capital

The valley’s second angel fund, The Treasure Valley Angel Fund is now open for business. It reached its first close milestone of $750,000 in July.  Full disclosure:  I am an investor in the fund and my firm, Loon Creek Capital helped guide the fund through the organizational effort.

The new fund presents a case study in the process of raising seed capital in Idaho. It took about 24 months from early discussions until the capital was raised.   Active fund raising began in January of this year and reached the minimum in July. 

Why does it take so long to raise capital?  There are several reasons:

• Investors are conservative.  There are always more reasons not to invest than there are to invest. 
• Investors are busy.  It’s hard to get the attention of busy people. In most cases someone has to sit down personally with an investor to review the business plan, explain the risks and the potential benefits. It takes time to get these appointments.
• There is usually a “minimum raise.” Most security offerings have a minimum amount to be raised before capital can be released to the company.  In the case of the angel fund, that minimum was $750,000.  While a minimum raise protects the investors, it usually means it will take longer to conclude the offering and begin to put the capital to work. 

The implication for entrepreneurs is it takes a long time to raise capital.  You must plan for this and be sure you are beginning to raise capital well in advance of the time you actually need it. 

Now that the fund has reached its minimum raise, it is accepting applications from entrepreneurs for funding.  Applications will be managed by the parent organization, the Boise Angel Alliance and can be submitted at www.boiseangelfund.com. 

In the first fund about 5% of the applicants actually received funding.  I don’t expect the second fund to be any less restrictive.  So entrepreneurs should make sure they have done their homework before applying.

The web site contains information on the kinds of deals in which the fund will invest, the typical terms, and the processes used to make the investment decision.  I strongly advise entrepreneurs to read through this information before submitting an application.  And they are welcome to contact me for an informal discussion if they believe that would be helpful.

The fund is authorized to raise a total of $2 million and will continue to seek qualified investors as it begins considering investments in local entrepreneurs.  To be qualified, investors must be residents of the State of Idaho, must qualify as an accredited investor (generally a net worth of more than $1 million not including the equity in his or her primary residence), and must represent that the investment does not exceed 10% of the investor’s net worth, exclusive of the investor’s home, automobiles and furnishings.  Additional information for potential investors is available at www.treasurevalleyangelfund.com.

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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 President of the Boise Angel Alliance (www.boiseangelfund.com), an investor in both of its funds, 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.

How To Make Convertible Notes Attractive to Investors

 A popular funding instrument for very early stage financing is a convertible note.  With this instrument, the investor loans the company money.  In exchange for the loan the investor accepts a promissory note.  The note will accrue interest at a high interest rate, perhaps prime plus 4% to 8% in today’s market.  Principle and interest are due at some point in the future.  At that time the investor can elect to convert principle and accumulated interest into stock in lieu of payment.

Typically the price at which the note can convert into equity is based upon a discount from the price at which stock is ultimately sold. The language may read something like:  “The note and accumulated interest can be converted into common stock at a discount of 20% from the price of the next equity round of at least $250,000.“

What this means is the entrepreneur and the investor do not have to negotiate the value of the company today.  Rather they recognize that at some point in the future the company will sell stock.  When that occurs, they will use the price of that stock sale to determine the price at which the investor can convert from debt to equity.

The advantages to the entrepreneur are that she does not have to negotiate and accept a lower value on her company today when the value will likely be higher later.  And, since convertible notes are simpler than stock sales they can usually be done faster and with lower legal fees than apply to stock sales. 

Theoretically, the investor’s position is at lower risk than had the funds been invested in stock.  But practically speaking, in an early stage company, there’s little difference between holding a note and holding stock.  If the company fails, both will be worthless.

A convertible note has one very large disadvantage to the investor.  His capital is at risk, but his upside is limited.  If, for example, the company is able to sell stock later at a valuation of $2 million, the investor will convert at a valuation of $1.6 million (20% discount from the $2 million).  This is likely substantially more than the investor would have paid had he insisted on purchasing stock rather than loaning the company money, even though his funds were at risk as if they were invested in stock.

For this reason many local angels do not participate in convertible debt offerings.  They don’t like the risk/return ratio.  However, a way around this is to negotiate a cap on the maximum value the entrepreneur will have to accept. For example, the above conversion language might be qualified:  “The note and accumulated interest can be converted into common stock at a discount of 20% from the price of the next equity round of at least $250,000, or a valuation of $1 million, whichever is less.“

This provision allows the entrepreneur to gain the benefits of a quick and relatively inexpensive transaction, while preserving for the investor the full upside should the company be highly successful.

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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 president of the Boise Angel Alliance (www.boiseangelfund.com) and a member of both of its affiliated angel funds. He 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. A version of this post was previously published in the Idaho Statesman's Business Insider.

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. ]

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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.

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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. 

The JOBS Act Should Make Early-Stage Capital More Accessible by Idaho Entrepreneurs

On April 5 the President signed into law the JOBS act, which stands for “Jumpstart Our Business Startups.”  The Angel Capital Association, to which the Boise Angel Alliance belongs lobbied in favor of the act. This law, which will be implemented over the next nine months, radically changes the laws as they pertain to raising equity capital in the United States.  In my opinion, the changes are for the better, although we must be mindful of the potential for abuse.

This is a complicated law.  The SEC is charged with writing a number of regulations. Until they are written, we can’t know exactly how the law will affect entrepreneurs and angels.  But there are key changes that have the possibility of making it easier for Idaho entrepreneurs to sell stock.

First let’s review pre-JOBS law.  Under those laws, you may not sell stock unless it is registered with the SEC (an expensive and time consuming process) or qualifies for an exemption.  Broadly speaking, there are two exemptions that are commonly used:

1.  Offer stock only to accredited investors (generally a net worth of more than $1 million excluding the equity in the primary residence) in private transactions. A private transaction means there can be no general solicitation including advertising or the use of the Internet.

2.  Offer the stock only to residents of one state in which case state law applies but federal law does not.

I wrote earlier about these two exemptions (see "State Small Corporation Registration" posted December 29, 2011).

The JOBS act removes the need for both of these exemptions for many businesses.  It

1.  Allows equity-based crowd funding.

2. Removes prohibitions on general solicitation.

Crowd funding is where an entrepreneur uses the Internet to solicit relatively small amounts from the universe of Internet users.  Until the JOBS act was passed, this was illegal in that offers were being made to individuals who were not accredited investors, and of course, the Internet is a means of general solicitation.  There are crowd funding platforms, but they ask for “donations,” not for the purchase of stock.

The JOBS allows up to $1 million of capital to be raised from non-accredited investors, so long as each  individual investor does not invest more than the lesser of $10,000 or 10% individual investment on all such investments during any one year. It also allows general advertising and preempts state law so this device can be used to raise money from throughout the US. 

It's not clear how the issuer will make sure a non-accredited investor has not invested more than $10,000 in all crowd-funded investments in any one year. The funding platform will have to be registered with the SEC, but it's not yet clear what this means or what obligations will be imposed upon the platform.

For offerings of more than $1 million, or where the company does not wish to be restricted to $10,000 per investor, a company may still use the accredited investor exemption, but is now allowed to advertise so long as the ads are focused on accredited investors.

We won’t know for sure how these new permitted activities will impact local entrepreneurs until the regulations are written. But generally I believe they will have a positive impact, making it easier for local entrepreneurs to raise equity capital.

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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. 

Why the Entrepreneurial Community Should Support the School Levies

I wrote earlier about the fact that new businesses account for most of the new jobs in our economy (“Where do jobs come from? June 20, 2011).  In that piece I argued that to create new jobs in the Treasure Valley, we needed to create an ecosystem that supported entrepreneurs.  Every since then I have been writing about one component of a healthy entrepreneurial ecosystem-early stage capital provided by angel investors.

Today I want to talk about another component of this ecosystem—intellectual capital.  We now live in the knowledge economy where much of the goods and services created by our  businesses, especially our new businesses, are dependent upon a well-educated workforce that can supply the necessary skills and knowledge.

All eleven of the businesses supported by the Boise Angel Fund depend upon access to an educated workforce to provide the brainpower they need to produce and market their cutting edge products and services.  They need, for example, engineers and marketeers; accountants, financiers and intellectual property attorneys; computer software writers and food chemists. None of them need unskilled or semi-skilled workers. 

We obtain these knowledge workers from two sources.  Some are produced by our education system locally.  Others are recruited to move here.  First lets address our own production.

We are not producing enough knowledge workers for our economy. For example, KTVB reported in November that Treasure Valley employers had openings for hundreds of computer programmers that they could not fill (“Demand for software engineers in the Treasure Valley outweighs workforce,” KTVB, November 15, 2011).

There is no quick or easy fix for this problem.  We will solve it only by providing a high quality, challenging education system, from kindergarten through Ph.D programs.

Our state, like most, has had to reduce the resources it can provide to the entire educational system.  Our educators have done a terrific job at holding the system together in the face of declining resources, but the system is fraying. 

Our colleges and universities have made up part of the shortfall through tuition increases, contributions and research grants.  But the K-12 schools have no such options.

They must either reduce services or ask the taxpayers to pay more.  Both the Meridian and Boise School Districts will ask the voters to raise their taxes to provide additional resources on March 13. 

It’s clear to me that the consequences of our failing to provide additional resources to the schools will be a lower quality education for these young people which will result ultimately result in fewer workers with the skills needed to match the demands of our employers.  And without the skilled employee base, our entrepreneurs will not be successful in creating new businesses.

 A note about importing workers.  Yes, we know many people move here for our quality of life.  But they bring families with them and high on their list of requirements in determining to move is the quality of the public education system.

So, my argument to the entrepreneurs who create our exciting new businesses and the angels who finance them, as well as to those who believe a healthy entrepreneurial ecosystem is important to our valley, is to support our local school districts by voting to increase their resources. 

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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. 

New Angel Fund Under Development

I am delighted to report that a new angel fund, to be known as the Treasure Valley Angel Fund is in formation and seeking investors.  The purpose of the Fund is to support economic development efforts by providing capital and advice to local entrepreneurs while providing an opportunity for the investors to make a return on their investment.

The CORE, an economic development group based in Meridian and focused on creating a CORE competency in the state in Health and Research sponsored the initiation of the fund. Leadership of the Core worked extensively with the Department of Finance to develop offering parameters that ensure that sales of interests in the Fund are properly qualified under the Idaho Uniform Securities Act.

Over the past few years both the Boise Angel Fund and Highway 12 have been potential sources of early stage capital for local entrepreneurs.   However, Highway 12 is no longer accepting applications for new investments and the Boise Angel Fund is nearly out of capital.  So a new source of capital interested in supporting valley entrepreneurs will be a welcome addition to the entrepreneurial ecosystem.

The Fund will be a “member-managed” LLC.  That means the investors (called “members”) in the fund will make the investment decisions. Once capitalized, the Fund members will appoint a screening committee to consider initial applications from entrepreneurs.  When the screening committee recommends an investment, a due diligence committee will be formed to thoroughly investigate the entrepreneur and his or her business plan, and if warranted, to negotiate the terms of a possible investment.  The recommended investment will then be brought to all the members for a vote.

Whether or not the Fund members agree to make an investment, members will be encouraged to help the entrepreneur by providing advice, access to their contacts, and such other assistance as may be appropriate.  Individual Fund members will be  free to make an investment in the company whether or not the Fund members decide to make an investment of Fund capital.

Before the Fund can make any investments, it must first raise capital to invest.  The Treasure Valley Fund is raising between $750,000 and $2 million.  Units of $50,000 each are being offered to qualified Idaho residents.

The offering to form the new fund is subject to a number of restrictions, the most important of which are:

1.  Only accredited investors (who generally must have a net worth greater than $1 million, excluding the equity in the investor’s primary resident or income greater than $200,000 per year) can participate in the Fund.

2.  Investors must be residents of the State of Idaho

3.  Any investment must not exceed 10% of the net worth of the investor excluding the value of the equity in the investor’s principle residence, furnishings and automobiles. 

Of course, such an investment is very risky and no one should invest in the Fund unless they can afford to lose their entire investment.

If you meet the above criteria and would like to know more, additional information and a copy of the Fund’s Confidential Placement Memorandum can be requested through the Fund’s web site at www.treasurevalleyangelfund.com.

I hope to chronicle the formation of the Treasure Valley Angel Fund over the coming months so that others interested in forming such capital pools might learn from the experience of the Fund.

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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. Loon Creek Capital provides consulting services to the Treasure Valley Angel Fund. He can be reached by email to kevinlearned@boisestate.edu or by phone at 208-426-3875.