How to Create an Angel Fund

The process for starting an Angel Investor fund is fairly start forward in comparison to forming a venture capital firm. This is because an angel investor fund has a far more simple legal and management structure. Let’s begin by discussing what a angel investment fund is or does.

Types of Venture Capital Fund

An angel investment fund is a business organization with the purpose of making seed investments directly in one or more target companies. Unlike a venture capital fund, an angel fund is exclusively made up or owned by wealthy individuals. The target companies are generally growth-oriented businesses, or startups, who need the investment capital to fund its growth. Unlike in a VC fund, this is not a scenario where professional investment managers raise money from a disconnected group of passive investors. The angel investors generally make a collective decision to invest their personal funds together in a specific target company. Any investor is likely to take part in the advising and mentoring of the companies in which they invest. Like a VC firm, the objective of the fund members is to make a profit on investor funds by selling or undertaking an initial public offering with the portfolio companies.

What is the Legal Structure of an Angel Fund?

An angel fund is generally a limited liability company formed for the specific purpose of investing in a target company. The LLC is manager-managed, where the investors elect a single individual or group of individuals to manage the day-to-day operations of the fund and to manage the investment process. The investors manage the fund as voting members of the LLC. The investors will hold a single type of ownership interest in the LLC.

Process for Raising and Administering the Fund

Raising Funds - Angel investors generally come together as part of a larger organization of angel investors. This larger organization will hold meetings and schedule company presentations for angels seeking to make an investment. Investors generally begin by reviewing a prospective company’s business plan and hearing an investor pitch from company representatives. If the angels are interested, they will come together to form an angel fund to meet the company capital requirements.

Deal Process - The managing member of the fund will negotiate the terms of the investment with the startup company. Further, s/he will orchestrate conducting the due diligence and the closing of the investment. This generally requires hiring a securities attorney and a financial accountant. Because the business seeking funding is offering to sell securities, it must comply with the applicable securities laws. The angel fund generally makes an investment that intends to last the startup company 18 months. At that point, it will consider a follow-on investment for another 18-24 months. If the fund sells its ownership interest to a follow-on investor, the fund is dissolved and the proceeds are distributed to the investors. If the fund decides to take part in a subsequent round of investment, it may seek additional funds from the existing angel investors or seek investment from other interested investors.

Expectation of Returns - Angel investors generally seek a return on investment within three years of investment. The fund will generally seek to sell its interest in the target business to subsequent investors, such as a VC firm, or back to the company itself in a leveraged buyout.

Regulatory Process Behind Founding a VC Fund

An angel fund faces several regulatory hurdles to formation and compliance. The act of investing in a startup is generally regulated by the Securities Act of 1933 (“1933 Act”). The 1933 act requires a company make extensive disclosures to prospective investors. 

The business will prepare a Private Placement Memorandum (PPM), which is a detailed business plan disclosing the major aspects of the company’s ownership, leadership, operations, strategy, and financial position. The angel investment group will generally manage the process of complying with the applicable securities law exemptions. If the fund later seeks additional investors, it must similarly provide adequate disclosures to the investors to comply with applicable securities laws.

Regulation D, Rule 506(c) provides the primary securities registration exemption used by startups seeking investment from angel investors. The rule requires that all investors be “accredited investors” and that the business file Form D with the SEC within 15 days of the funding transaction. 

State securities laws also apply to these deals. This may may require perfecting an exemption from state securities registration or meeting the minimum public disclosure requirements. The Rule 506 exemption generally applies to state-level regulation of securities as well; however, states often have a “de minimis” exemption for issuances of securities to less than 15 accredited investors.