Closing Deals with Angel Investors: A How-to Overview

Introduction: So Far, So Good

So you’ve made it this far: you’ve found an angel investor who’s interested in investing in your business, you’ve made your pitch or submitted your business plan, they like it and want to move forward. All is going well so far. 

What happens next?

This is where things can and do get tricky. Closing deals with angel investors for an entrepreneur can be difficult and time consuming, but that doesn’t mean doing so is not worthwhile. After all, the future of your business can depend on it.

The purpose of this post is to provide an overview of how entrepreneurs close deals with angel investors without getting too stressed out and, by being more familiar with the process, maybe even get more out of the deals than they otherwise would.

“Due Diligence:” The Angel Investor Way

Attracting an angel investor is a big job in its own right, but once an entrepreneur has an angel investors’ attention and approval, the hard work begins for both. 

For entrepreneurs, this work entails preparing the documents and information requested by the angel investor. For angel investors, it involves reviewing the documents and information submitted by entrepreneurs. In the best cases, the process is cooperative and leads to a deeper understanding of both parties. In the worst cases, deals break down in the process.

This sometimes tedious process is often called “due diligence,” and in it the angel investor sets the rules and pace of the game. For better or worse, all the entrepreneur can do is play along and hope for the best. So it is important to play the due diligence game to the best of one’s abilities.

Here are some of the documents and information angel investors request during their due diligence, noting that there are no fixed requirements and each angel investor can differ in the materials they request:

• Pitch or business plan, expanded from earlier submission
• Financials, current and projected
• Legal documents, incorporation and organizational documents etc.
• Marketing materials
• Company registration and licensing documents
• Professional references
• CVs and Resumes
• Testimonials

This is not a complete list of documents and information that can be requested by angel investors during due diligence, but it is an indicative list. It is important to keep in mind that failing to submit requested documents or information, or not doing a sufficiently good job with them, can lead to the rejection of a funding application.  

On the flipside, if all the documents and information submitted pass muster, the deal can proceed to the next stage, the famous Term Sheet, to which we now turn.

The Holy Grail: Term Sheet

For many entrepreneurs dealing with angel investors, there is one and only one goal: to receive a Term Sheet from them. While this is the first and an important step in the process of closing a deal, it is not the last and there are other important steps as well, as we will see.

What is a Term Sheet? 

Basically, a Term Sheet is a document that outlines the major terms of the agreements that follow between the angel investor and entrepreneur’s company. It is important to note that most Term Sheets are not legally binding agreements, but rather an understanding between the parties as to the major terms of the legal agreements.

Term Sheets differ from deal to deal and from angel investor to angel investor, but generally they cover the following major terms of the agreements that follow:

• Ownership percentages
• Dividends or interest to be paid
• Amount of investment
• Duration of Investment
• Duration of agreements
• Marketing of investment
• Confidentiality

While this may sound like a lot to cover, Term Sheets are usually no longer than one or two pages. However these two pages can take a long time and a lot of negotiation to be agreed upon between angel investor and entrepreneur. 

It is vital to get the terms of the Term Sheet right before proceeding to the final step, which are the legal agreements that make the deal between angel investor and entrepreneur a reality, and to which we now turn.

The Final Stage: Legal Agreements

When someone says “we closed the deal,” that usually means one thing: the parties have signed legal agreements. Indeed, after the long and sometimes difficult process we have just surveyed, reviewing and signing the legal agreements may seem an easy ending. 

But it is not.

The legal agreements that culminate the dealmaking process we have covered are the final and perhaps most important step in closing deals with angel investors. This is because, while all the previous steps have informed this last one, it supersedes all others and gives final and lasting form to the arrangements between entrepreneur and angel investor.

We strongly recommend seeking the advice of an experienced attorney in reviewing the legal agreements that close the deal, they can be highly technical. The overview presented here is intended solely for informational purposes and does not constitute or substitute for professional legal advice. It should, however, give you a sense of what to expect.

The four most common legal agreements that “close the deal” between entrepreneurs and angel investors are:

Purchase Agreement: This is the agreement by which the angel investor officially purchases the shares of the entrepreneur’s company. It is often relatively short and simple, and can cover topics such as Preferred Shares vs. Common Shares, indemnification, non-competition and confidentiality, among others. 

Shareholders Agreement: This is the agreement that governs the relationship between shareholders, or in this case between the angel investor and entrepreneur as shareholders. This can be a lengthy and dense document, and covers such topics as the workings of the board of directors, ownership percentages and dividends, special shareholder voting issues and so on. 

Investment Agreement: This is the agreement that replaces a purchase agreement and shareholders agreement combination if the entrepreneur’s company is a sole proprietorship. It serves a similar purpose as these agreements and covers many of the same topics as them.

Convertible Note:  This document, which is usually used instead of the agreements just mentioned by some angel investors, sets out a short-term loan to a startup that can convert into equity, or ownership, at a future qualified event, such as a larger funding round or sale of the company. It functions as debt initially, but the principal and accrued interest are then exchanged for a predetermined number of company shares.

This overview of the legal documents that literally “close” deals between angel investors and entrepreneurs is not intended to be exhaustive. Other legal instruments can be and are used. However, they are the most widely adopted and can be considered as a guide.

Conclusion: Deal Done, Now What? 

What happens after an entrepreneur closes a deal with an angel investor? 

You get funded!

But the relationship between angel investor and entrepreneur does not end with funding. Sometimes it just starts with it, growing and deepening over time. 

In this post, we have presented an overview of how entrepreneurs close deals with angel investors. It remains for another post to explore what happens between the two after the deal is closed.