Angel Investor

What is an angel investor?

Angel investor (business angel) refers to a wealthy private individual who invests their own capital in young, unlisted companies, usually at an early stage. Often the angel additionally contributes entrepreneurial experience, industry knowledge and contacts. Unlike a fund, the angel decides about their own assets and is not bound to a fund term. In German usage, the angel is usually called a Business Angel, or simply an Angel.

Angels typically finance the period after the founding, which is often funded from the founders' own resources or personal circle. This phase extends to the first institutional round, that is, the first round with professional funds. They invest individually, through business angel networks or pooled in an angel syndicate. Legally, they invest through a capital increase (the issue of new shares in the company) or through a loan that is later converted into shares. Their rights are set out in the investment agreement and in the shareholders' agreement. In later rounds, angels usually remain shareholders and take part in the resolutions that an institutional financing requires.

Types of business angels

• Entrepreneurially experienced angels: active or former founders and executives who, alongside capital, contribute knowledge from building a comparable company, for example on sales, organisation or financing.
• Industry experts: open up access to customers, partners and skilled staff in a particular industry. Their value lies in contacts and in their credibility in that market.
• Financially oriented angels: invest mainly as a capital investment, often in several companies in parallel, and take little part in operations.
• Professional angels with their own vehicle: invest regularly and on a larger scale, often through their own holding company, and occasionally take the lead in early rounds.

The boundaries are fluid. For the company, what matters is whether the angel wants to contribute time and contacts as well as capital, and what expectations of a say follow from that. These expectations should be discussed expressly before the investment, because they must be compatible with the decision-making and control rules (governance) of later institutional rounds.

Forms of investment by a business angel

Direct investment through a capital increase

In a direct investment, the angel takes over new shares from a capital increase. The resolution of the shareholders' meeting is notarially recorded, and the takeover of the new shares takes place by a declaration that is notarially recorded or certified. With entry in the commercial register, the capital increase becomes effective; the angel is then a shareholder with voting rights and a claim to a share in the profit.

Convertible loan and SAFE

Angels often invest first through a convertible loan. They provide a loan that is converted into shares in the next financing round at a discount to the round price or at a valuation cap. The valuation question is thus postponed to the next round. If the agreement contains obligations to take over or assign shares, it is regularly notarially recorded in practice, because otherwise individual provisions risk being invalid.

A SAFE (simple agreement for future equity), by contrast, is not a loan. It is an instrument from the US market that promises future shares without a right to repayment and is uncommon in Germany. German early-stage financings use the convertible loan or the direct investment for this.

Taxes for business angels and the INVEST grant

If an angel holds the investment as private assets, the size of the holding matters. If the angel held an interest of at least 1% at any time within the last five years, a capital gain on disposal falls under Section 17 of the German Income Tax Act (EStG). It is taxed under the partial income method (Teileinkünfteverfahren), that is, only 60% of it at the personal tax rate. In this case, losses on disposal are generally deductible at 60%. Below this threshold, the flat-rate withholding tax of 25% plus solidarity surcharge applies.

Many angels invest through their own investment GmbH (holding structure). Its capital gains on disposal are 95% tax-exempt under Section 8b of the German Corporate Income Tax Act (KStG), which makes reinvestment of the proceeds easier; tax is imposed on the angel personally only on a later distribution. The downside: losses from a failed investment do not reduce profit in the GmbH (Section 8b(3) KStG). For early-stage investments with a high failure rate, this point must be considered when choosing the structure.

The INVEST grant is a federal government support programme that grants private investors a subsidy when they acquire shares in young, innovative companies. Whether the programme is offered at the time of the investment, which companies and investors are eligible, and which minimum and maximum amounts and holding periods apply, follows from the funding guideline in force at the time. The application is made by the investor after the company has had its eligibility certified. The sequence of certification, application and share acquisition laid down in the guideline must be observed.

Angels in later financing rounds

With the first institutional round, the role of the angels changes. They remain shareholders but are diluted by the new shares: their percentage falls because the share capital grows. They often lack the funds to take part pro rata in large rounds. A contractual right to a follow-on investment in the amount of their percentage is therefore often only partly useful to them.

At the same time, they take part in the resolutions that a Series A requires: capital increase, amendment of the articles of association, redrafting of the shareholders' agreement and often the waiver of subscription rights. The subscription right is the right to take over new shares in proportion to one's own holding. With many individual angels, this means many signatures, powers of attorney and votes before the notary appointment. Angel investments are therefore often pooled, for example through a pooling agreement in which the angels undertake to vote uniformly and grant a joint power of attorney. Contributing existing shares to a joint company, by contrast, is a share transfer with its own tax questions.

Worked example: share and value of an angel investment over two rounds

An angel takes part with EUR 50,000 in a seed round of EUR 500,000 at a pre-round valuation of EUR 2 million. Two years later a Series A of EUR 4 million follows at a pre-round valuation of EUR 12 million.

• Valuation after the seed round: EUR 2 million + EUR 0.5 million = EUR 2.5 million
• The angel's share: EUR 50,000 divided by EUR 2.5 million = 2.0%
• Valuation after the Series A: EUR 12 million + EUR 4 million = EUR 16 million
• Share without taking part in the Series A: 2.0% × 12/16 = 1.5%
• Notional value of this share at the Series A price: 1.5% × EUR 16 million = EUR 240,000
• Amount needed to maintain the 2.0% share: 2.0% × EUR 4 million = EUR 80,000
• Check: 1.5% + EUR 80,000 divided by EUR 16 million (0.5%) = 2.0%

Even without taking part, the angel remains above the 1% threshold with 1.5%, so that a later capital gain on disposal in private assets falls under Section 17 EStG. Because what matters is the holding within the last five years, this also applies if later rounds reduce the share below 1% shortly before the sale. The EUR 240,000, 4.8 times the amount invested, is a paper value. What proceeds actually arrive depends on the purchase price and on the liquidation preferences of the later investors, that is, their priority in the distribution of proceeds.

Distinction: business angel, venture capital and family office

• Angel syndicate: association of several angels under a leading investor, usually pooled through a company. The individual angel there follows the review and negotiation of the syndicate leader.
• Venture capital: funds invest their investors' capital according to a defined strategy and term, usually in larger amounts and after a more detailed review.
• Family office: manages family wealth with its own organisation and an investment team. An angel decides personally.
• Co-investor: participates on the terms of a lead investor. When angels take part in institutional rounds, they usually have this role.

Common mistakes

• Too many individual shareholders. Each further angel on the list of shareholders increases the effort for resolutions, powers of attorney and notary appointments in the next round. Pooling early avoids this.
• Large share for little capital. If a high share is given up at an early stage at a low valuation, room is lacking later for founders, employee participation and institutional investors.
• Formal defects in the convertible loan. A convertible loan with takeover obligations that has not been notarially recorded makes the conversion open to challenge. This comes to light in the due diligence of the next round at the latest.
• Unclear role. Without agreement on say, scope of information and time commitment, expectations arise that collide with the governance of an institutional round.
• Special rights of individual angels. Individual promises on veto rights or valuation protection make negotiation with the lead investor of the next round harder.
• Funding conditions overlooked. If the INVEST grant was used, the requirements of the funding guideline must also be observed in later share transfers.

Frequently asked questions

How much does a business angel typically invest?

The range is wide. As a rough rule of thumb, individual investments range from a few tens of thousands to several hundred thousand euros. Larger amounts usually come about through pooled investments or professional angels with their own vehicle.

How does a company find a business angel?

Usually through recommendations from other founders, existing investors or advisers. Further routes are business angel networks with regular pitch events, accelerators, university start-up centres and platforms through which syndicates offer investments. Prospects are good with angels who have gained experience in the company's own market, because they understand the business model more quickly.

Who can become a business angel?

Any private individual with freely available assets; no licence is required. Because early-stage investments often fail, experienced angels commit only a small part of their assets in this way and spread it across several companies. For getting started, networks and syndicates offer the opportunity to follow the review of experienced investors.

Does an angel investment need a notary?

For a direct investment in a GmbH, yes, because the capital increase requires a notarially recorded resolution. For convertible loans, whether a formal requirement applies depends on the content; in practice they are often notarially recorded.

Do angels sign a confidentiality agreement?

Usually not before the first conversation. It is generally concluded only when in-depth documents such as contracts, customer data or technical details are disclosed. The investment agreement and the shareholders' agreement later contain their own confidentiality obligations.

The Roemer Capital view

Roemer Capital encounters business angels mainly as existing shareholders when preparing a financing round from EUR 1 million. Roemer Capital therefore records early which angels are invested, which rights earlier agreements grant them and whether convertible loans are still to be converted. This information belongs in a cleaned-up shareholder structure before the first investor opens the data room.

For the timetable of a round, what counts is how quickly resolutions can be passed. Roemer Capital agrees with the founders and the law firm whether powers of attorney, a voting agreement or a pooling of the angel shares before the notary appointment make sense. It also asks whether earlier investments were supported with the INVEST grant, because its conditions may have to be observed on a share transfer.