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Angel FAQ
- What is an Angel? How do I become an Angel?
- What are the requirements for an investor to be an Accredited Investor?
- Do I have to be an Accredited Investor to be an Angel? To invest in new businesses affiliated with the Angel Law Forum?
- Can I invest in a start-up enterprise or emerging growth business and receive "freely tradable" stock? If not, what are the likely limitations on the liquidity of my investment?
- What are the tax advantages to investing in start-up or early-stage enterprises?
1. What Is An Angel? How Can I Become An Angel?
Individual investors who qualify as "accredited investors" under the SEC's regulations and who make equity investments in early-stage companies often are referred to as "Angel" investors or, simply, "Angels." Often, an enterprise in its very early stages is too young for the venture capital community to be willing to invest in it, or it seeks an amount of money that may not be substantial enough to justify the expense to a venture capital fund that investment would require. Sometimes, the founders of the new business are simply unwilling to give up the degree of control in their enterprise that the venture capital funds often require. An individual investor, an "Angel," with a net worth or income sufficient to qualify her as an "accredited investor" under the federal securities regulations, may step in to provide the enterprise with its much-needed early-stage financing.
In addition to "cash angels", there are also people and organizations willing to invest time and to offer their expertise or contacts to fledgling companies in exchange for company equity. These "strategic angels" are highly valuable to cash-strapped young enterprises, as companies then need less cash in order to acheive their goals. In this sense, strategic angels may be considered "as good as cash" to emerging companies. In the rush to find cash, many entrepreneurs overlook strategic angels as a valuable resource.
2. What Are The Requirements For An Investor To Be An Accredited Investor?
Regulation D under the Securities Act of 1933 defines an "accredited investor" as an investor whose financial net worth, investment sophistication or particular relationship to an issuer makes her more likely than others to be able to bear the risks associated with investment in the securities of an issuer that may be relying on one of the exemptions from federal securities registration requirements provided under the Regulation D safe harbor rules.
A prospective investor will be considered an "accredited investor" under Regulation D if:
1.The investor is a natural person whose net worth, or joint net worth with that person's spouse, at the time of purchase exceeds $1 million; or
2. The investor is a natural person whose individual gross income exceeded $200,000, or whose joint income with that person's spouse exceeded $300,000, in each of the two (2) most recent years, and who reasonably expects to reach the same income level in the current year; or
3. The investor is a trust with total assets in excess of $5 million not formed for the specific purpose of acquiring the securities offered, whose purchase is directed by a person who has such knowledge and experience in financial and business matters that such person is capable of evaluating the merits and risks of the proposed investment; or
4. The investor is an entity, all of the equity owners of which are accredited investors; or
5. The investor is (i) a bank as defined in Section 3(a)(2) of the Securities Act, or any savings and loan association or other institution as defined in Section 3(a)(5)(A) of the Securities Act (whether acting in its individual or fiduciary capacity), (ii) a broker-dealer registered pursuant to Section 15 of the Securities Exchange Act of 1934, (iii) an insurance company as defined in Section 2(13) of the Securities Act, (iv) an investment company registered under the Investment Company Act of 1940 or a business development company as defined in Section 2(a)(48) of such Act, (v) a Small Business Investment Company licensed by the United States Small Business Administration under Section 301(c) or (d) of the Small Business Investment Act of 1958, (vi) any plan established and maintained by a state, its political subdivisions, or any agency or instrumentality thereof, for the benefit of its employees, if such plan has total assets in excess of $5 million, (vii) an employee benefit plan within the meaning of Title I of the Employee Retirement Income Security Act of 1974, and either the employee benefit plan has assets in excess of $5 million, if a self-directed plan, with investment decisions made solely by persons that are Accredited Investors, or the investment decision is made by a plan fiduciary, as defined in Section 3(21) of such Act, that is either a bank, savings and loan association, insurance company or registered investment advisor, (viii) a private business development company as defined in Section 202(a)(22) of the Investment Advisors Act of 1940, or (ix) an organization described in Section 501(c)(3) of the Internal Revenue Code, corporation, Massachusetts or similar business trust or partnership, not formed for the specific purpose of acquiring the securities offered, with total assets in excess of $5 million; or,
6. the investor is a director, executive officer or principal of the issuer.
The Securities and Exchange Commission has expressed the view that, in determining personal income, an investor should add to adjusted gross income any amount of income that is tax exempt under Section 103 of the Internal Revenue Code, losses claimed as a limited partner in any limited partnership as reported on Schedule E of Form 1040, deductions claimed for depletion under Code Section 611 and any amount by which income from long-term capital gains has been reduced in arriving at adjusted gross income pursuant to Code Section 1202 (See Frequently Asked Question Number 5, below, for a brief discussion of Section 1202).
If a prospective investor is investing through such investor's individual retirement account or grantor (revocable) trust, the foregoing suitability standards will apply to the investor as if such investor were investing directly on such investor's own behalf. The same will be true if an investor purchases Units through a Keogh plan, 401-K plan or other pension or retirement plan provided that the plan (a) provides for a segregated account for the investor-beneficiary and (b) gives the investor-beneficiary the power to direct each plan investment to the extent of such Investor-beneficiary's voluntary contribution plus such Investor-beneficiary's share of vested employer contributions. The suitability of such plans will be determined according to the suitability of the investor-beneficiary. A prospective investor seeking to make an investment for such investor's retirement plan should discuss the proposed investment with his, her or its plan consultant or tax advisor to determine whether the investment satisfies diversity, "prudent man," and other requirements which may be applicable to retirement plan investments.
3. Do I have to be an Accredited Investor to be an Angel? To invest in new businesses affiliated with the Angel Law Forum?
Most companies seeking to raise capital at the very early stages will require that their investors be accredited investors. In some circumstances, however, businesses may be able to raise funds from a limited number of individual investors who do not qualify as "accredited investors."
Some early-stage companies may also take advantage of certain federal and state regulations that can allow them to sell securities to an unlimited number of investors who meet standards other than the federal "accredited investor" qualifications. One such regulation is Section 25012(n) of the California Corporations Code, which allows a California issuer to sell its securities, without obtaining a permit, to an unlimited number of investors who meet certain qualifications. For individual investors, the requirements are a minimum net worth of $500,000, exclusive of home and automobiles, or annual income of at least $100,000. A coordinating regulation adopted by the SEC lets these securities offerings proceed without any federal filing.
4. Can I Invest In A Start-Up Enterprise Or Emerging Growth Business And Receive "Freely Tradable" Stock? If Not, What Are The Likely Limitations On The Liquidity Of My Investment?
Most of the securities issued by early-stage companies in private placement offerings are likely to be deemed "restricted securities" under Rule 144 of the Securities Act. Investors who acquire shares of stock that are considered restricted securities will not be able to sell their shares until the expiration of a minimum one-year holding period. Also, an investor seeking to sell shares of stock subject to Rule 144 must comply with certain volume sale limitations under the rule, and the sale cannot be consummated unless the issuer is in compliance with Rule 144's publicly available information requirements.
5. What Are The Tax Advantages To Investing In Start-Up Or Early-Stage Enterprises?
If investors retain for at least five years securities that qualify as "small business" stock under the Internal Revenue Code, they may be able to obtain the beneficial tax treatment afforded to some capital gains by Internal Revenue Code Section 1202. This statute excludes from gross income a portion of the gain realized by an investor from the sale of qualified small business stock (as defined therein) held for more than five years.
Under Section 1045 of the Internal Revenue Code, investors who sell stock that qualifies as small business stock under Section 1202 may roll over their gains into new qualifying stock on a tax-free basis. Investors can continuously defer taxation on qualifying small business stock capital gains by rolling over gains from one small business investment into another qualifying investment. Investors can continue to roll over such successive gains for an unlimited period.
Recognizing that start-up stage investing is more risky than later stage investments, Congress also has provided a limited tax break for very early stage investors in companies which fail. Section 1244 of the Internal Revenue Code provides that such loss will be allowed as an ordinary loss (instead of a capital loss) if the investor purchased stock in the company before it had issued and sold $1 Million worth of securities. For high-bracket investors, this can represent a recovery of almost one-half of the investment loss, in the year the loss is realized. The amount each investor can claim under Section 1244 is $50,000 per year, or $100,000 for a married couple filing jointly.
Prospective Angel investors should consult their qualified tax advisers and legal counsel for an in-depth explanation of how these tax provisions may affect them individually.
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