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Updated August 29, 2023You’re reading an excerpt of Angel Investing: Start to Finish, a book by Joe Wallin and Pete Baltaxe. It is the most comprehensive practical and legal guide available, written to help investors and entrepreneurs avoid making expensive mistakes. Purchase the book to support the authors and the ad-free Holloway reading experience. You get instant digital access, commentary and future updates, and a high-quality PDF download.
Whether you should engage your own lawyer depends on a number of factors, including your level of experience, how much you are investing, and the context in which you are investing.
If you are investing as part of a group of experienced angel investors, and someone else in the group is the “lead” in performing due diligence and negotiating deal terms, then it is likely that you do not need your own lawyer. The group of angels with whom you are investing should have a lawyer representing their interests collectively, including yours. Angel groups often work with the same law firm for many deals, and so they usually have high confidence in that firm’s skills and experience.
In addition to managing deal terms, the lead investor in the group will play a role in assessing the need for and organizing any legal due diligence on the company. If you have any specific concerns regarding legal due diligence, whether that involves corporate formation, governance, or intellectual property rights, you can bring those concerns to the lead investor. If you do not feel your concerns are being adequately addressed, you can hire your own attorney to do a review.
That said, if you have a lot of money at stake or you do not have complete confidence in the law firm or individual lawyer representing you and your co-investors, then you can hire your own attorney (at your own expense) to review the documents for you. It would create an awkward dynamic, however, if your lawyer was also negotiating directly with the entrepreneur. You might instead hear the advice of your lawyer where it differs from the way the deal is being negotiated and documented, and bring it to the attention of your lead investor.
If you are investing on your own, especially if you are fairly new to angel investing, it is highly recommended that you use a qualified attorney with experience in early-stage investments to represent your interests.
important It’s common when investing solo to do so through a convertible note. You may find an opportunity to invest in an exciting company via a convertible note with rewards for being an early investor. Convertible notes can be quite straightforward, but as we discuss in the section on the topic, a properly drafted note which covers all of the potential scenarios of acquisition, default, non-qualified financing, and so on can become quite complex. If you have not made a similar convertible note investment before, we would recommend that you have a lawyer review the note. You can negotiate directly with the entrepreneur based on your knowledge of the general deal terms while making it clear to the entrepreneur that you will still have your lawyer review it after you have come to general agreement on terms. A legal review of a convertible note should not be expensive.
examplePete is a scrappy investor (having been a scrappy entrepreneur), and he came across an opportunity to invest early in a startup that had just come out of an accelerator. Pete did his business due diligence of this very early-stage company and relied on the reputation of the accelerator and the major law firm that it used for all of the companies in its class to give him confidence that no legal counsel was required for the legal due diligence. He also used a very standard two-page convertible note term sheet with an early investor preference and so was able to complete his $25K investment without incurring legal fees for himself.
Another common scenario is that you are investing in a deal as a solo investor alongside an angel group or VC. The lead investor might be a VC or other institutional investor or another angel investor. You generally benefit from following their lead (figuratively and literally) in this scenario, with a couple of important caveats:
Major vs. non-major investors. A “major investor” is usually defined as someone investing above a certain amount of money, depending on the amount the company is raising (in a $2M deal, major investors might be those investing $250K or $500K, for example). They may get certain rights that non-major investors do not get, such as information rights and pro rata participation rights. Review carefully any mention of rights that apply only to major investors.
Non-participation penalties (pay-to-play provisions). Be aware of any terms that penalize investors who do not step up to the next round pro-rata (commonly referred to as pay-to-play provisions). You may not have the resources to participate in future investment rounds for a company. Follow-on rounds in companies that are succeeding is part of the institutional investment model, and so those institutional investors may be motivated to capture a bigger share of their winners at your expense.
You always have the right to have your own attorney review any documents at your own expense. Use your own judgment as to how sophisticated your co-investors are and whether or not your interests are aligned in all cases. If you do hire your own lawyer, be tactful as to how your lawyer interacts with the lead’s attorney. In good times and bad, you are going to want a good relationship with your co-investors.
Some very active angel investors have terms and/or rights that they want to have in any deal. For example, they may feel that they don’t want to make any investment in which they don’t have the right to get quarterly financial statements from the company (information rights). Or they have been burned with other investors getting better terms, and they won’t do deals in which someone else who is investing at the same time can get a better deal (most favored nation clause). Rather than arguing with the lead investor as to whether they should be considered a “major investor” and get information rights, for example, they have a side letter prepared to accompany almost all of their investments.
The side letter (or side letter agreement) is an agreement between an investor and the company in which the company agrees to provide the investor with certain rights that are not otherwise present in the investment documents. This side letter usually includes terms like information rights, pro rata rights, and a most favored nations clause.
Assuming that the company is willing to sign a side letter agreement, the investor now has assurance that they have the terms that they specifically care about, whether or not the lead investor worked to secure them those rights.
We have included in a robust investor side letter in the appendix.
If investing in a group, it is not uncommon for the lead investor to ask the company to reimburse its reasonable attorneys’ fees, subject to a cap. This gets more common the larger the size of the round. Venture capital funds almost always have companies reimburse their reasonable attorneys’ fees. Series A rounds very often have a fee reimbursement provision for the investors. It is less common in Series Seed rounds or convertible debt or equity rounds. That said, the Series Seed Documents is a commonly used set of fixed-price financing documents in early-stage investing; and it provides that the company will reimburse $10K in legal fees. The more you are investing, either individually or as a group, the more comfortable you should feel asking for this provision. If you are investing $500K, definitely ask.