Using FounderCatalyst as an investor

Introduction

I remember starting out as an angel investor and thinking that the investment process was fairly opaque - understanding how to analyse potential investments, the investment process itself, the tax rules and the expected return was a steep learning curve. This guide aims to get you up to speed quickly. It's a companion guide to our similar blog aimed at founders: From bright idea to fully funded.

Some of the language used in the equity investment space may be unfamiliar, so our handy glossary might be a useful companion to this guide.

Too long; didn't read: If you want to cut to the chase and understand specifically how to invest using FounderCatalyst then see this section or this walkthrough video.

Contents:

1. Why become an angel
2. All about SEIS & EIS
3. The risks of making an investment
4. Types of angels
5. Your Investment Terms
6. Documents used in a funding round
7. Other ways of investing
8. Building a Portfolio
9. How to invest with FounderCatalyst
10. What happens post-investment?
11. Your ongoing relationship with the startup
12. Future funding rounds...and dilution
13. Further reading

Why become an Angel?

There are dozens of reasons why people angel invest, we cover the most common below. In reality, most people will pick a specific investment based upon several of these items.

To support family and friends

At the start of their journey, many founders turn to family and friends for investment. Though it's worth noting that the very attractive SEIS/EIS tax schemes (more on those later)cannot be used by some family members:

• parents, grandparents and great-grandparents
• children, grandchildren and great-grandchildren
• spouses and civil partners

Interesting to note: siblings and step-parents can make use of the SEIS & EIS though.

Tax breaks

The SEIS and EIS schemes are amazingly tax efficient for investors - we've detailed the key tax benefits in another post. Without these schemes the investment landscape in the UK would look very different.

To make money

It is very rare, but sometimes an investment can generate an income for investors by paying out a dividend. However, most of the time the aim of angel investing is for the business you've invested in to exit via some route. For example, through an IPO or via an acquisition of some kind.

The kind of returns you can expect from an investment have been detailed in some research undertaken by FounderCatalyst.

For paid work

Some angels invest specifically with the aim of becoming an advisor, Non-Executive Director (NED) or Chairman in your business. Typically these will be paid roles and they may well expect a discount on the price they pay for shares too.

It pays to think carefully before agreeing to this kind of arrangement.

To do good

We cover more details on this element below, however some people invest to support certain impactful causes.

All about SEIS and EIS

The benefits of SEIS and EIS

The tax breaks for investors are amazing. As an example, if you invest £20,000 under SEIS in a qualifying startup:

• You get 50% of your investment back, offset against your personal tax bill. In this case, you would get £10,000.
• You pay no capital gains tax on any increase in value at the point of exit. This could be a saving of ~20%, depending upon your tax status at the time of the event.
• There is additional downside protection, known as loss relief, which varies depending upon your tax position. But you can potentially achieve an additional ~23% of your investment back if your company folds, depending upon your specific tax situation.
• The investment is likely to be exempt from inheritance tax, provided that the shares have been held for at least 2 years and are held at the date of death. At the time of writing, IHT is charged at 40% for any amount above your threshold, meaning that IHT exemption under SEIS and EIS can be very useful for estate planning.

The CGT / Inheritance benefits under the EIS scheme are identical to SEIS, but the up front tax relief is reduced to 30%. The loss relief is less too.

HMRC have definitive documentation on how to make use of Income Tax and / or Capital Gains Tax reliefs at HS393 and have HS341 relating to EIS income tax and HS297 referring to EIS capital gains tax.

Worth Capital provide a great tool to help you model a specific investments tax relief.

SEIS & EIS Limits for Investors

Investors are limited to making £200,000 in investments under the SEIS scheme per year as of April 2023.

The limits for other schemes are helpfully published by the government:

You can claim back 50% of an SEIS investment against your Income Tax bill. For example, if you invested the full £100,000 into a SEIS-qualified company you could claim back £50,000 in Income Tax relief.

Assuming you have not exceeded your SEIS relief limit for this previous tax year, you can also 'carry back' SEIS relief to the immediate tax year preceding your SEIS investment.

It is worth noting that you cannot use 'carry forward' - you are unable to offset your investment in this year or one year prior, though, if the timing is right, an Advance Subscription Agreement can sometimes be useful to make use of next year's tax relief via an investment you make today.

SEIS & EIS Limits for Startups

Note: There are proposed changes to the current limits as detailed in our article.

Under SEIS, a qualifying startup can raise up to £250,000 for a period of up to three years from the point that the business starts to trade.

Under EIS, a qualifying startup can raise up to £12m over a period of 7 years, with a maximum of £5m per year. This is a further flavour of EIS, known as a Knowledge Intensive Company (or KIC), which allows a company to raise £20m over 10 years with a maximum of £10m per year.

Who can make use of SEIS/EIS?

To make use of these schemes:

1. You can only claim relief against the amount of Income Tax you pay in the UK.
2. There are complex rules around which family members can invest under the schemes. But as a general rule your spouse, parents, children, grandchildren or grandparents can't invest under the schemes, however your siblings, cousins, aunts or uncles and step-parents can.

How do I know an investment will qualify under SEIS or EIS - advance assurance

To provide comfort that any investment you make should qualify for the expected tax reliefs, you should ensure that the company has 'advance assurance' in place. Advance assurance is a process undertaken by HMRC to review a startup, validating that any investment should benefit from the tax reliefs offered by the scheme(s).

When a company receives advance assurance, HMRC confirms this as follows:

Thank you for your correspondence dated date requesting advance assurance. You’ve asked us to give you this assurance based on the details in your request.

This letter gives you the assurance below.

Seed Enterprise Investment Scheme (SEIS) We believe we’ll be able to authorise the company to issue compliance certificates under Section 257EC(1) of the Income Tax Act (ITA) 2007. This is based on the information in your application. The compliance certificates would relate to the shares to be issued. You’ll also need to send us an accurate and fully completed copy of form SEIS1.

More information We give this assurance based on the legislation which is in place on the date of this letter. If the legislation changes and takes effect on or before the date of any share issue, the assurances we’ve given may no longer apply.

We cannot guarantee that any particular subscriber will get relief under SEIS. For more information about this, go to www.gov.uk and search for ‘tax relief for investors’.

What happens next When the company has issued the shares, you must complete a compliance statement. You should send it to the address at the top of this letter. You can find compliance statements on our website. Go to www.gov.uk and search for ‘SEIS’. Then select the first result and read the section > ‘How to apply’. We no longer accept old versions of compliance statements. Please read the instructions on the form carefully and make sure you send it to us within the time limits.

You’ll also find more information about the SEIS in our Venture Capital Schemes Manual. Go towww.gov.uk and search for ‘VCM35000’ for the SEIS.

The obvious caveats are:

1. Legislation can change, meaning that your investment no longer benefits under the scheme(s).
2. You personally need to be eligible to use the scheme.
3. The HMRC advance assurance is only as solid as the information provided by the startup. If the information was incomplete or incorrect then you still may not receive the benefits you are expecting.
4. Finally, the schemes are brittle and it is easy to 'break' SEIS/EIS even once relief is claimed, as per our article.

The risks of making an investment

To a large extent, once you make an investment in a company you have very little control over the ensuing process. You may get some investor consents to control (to some extent) what founders can do, they may also make undertakings to ensure they do / don't do certain things.

But, in general, you will have very little influence over the outcome of the investment and you'll only get your money back when the business exits, one way or the other.

Let's take a look at some of the potential risks that can occur along the way:

• The company breaches (S)EIS rules and you lose tax relief. This could include repaying your up front tax relief that you've already banked and paying Capital Gains Tax on exit.
• You find out you don't have sufficient tax to offset your investment against
• The company enters liquidation. You should be able to benefit from loss relief, which somewhat softens the blow.
• Later investors enter with better terms. You should have the right but not obligation to use preemption to maintain your % ownership. However, VCs in particular will invest using terms that won't be made available to you (such as liquidation preferences, investor drag rights, anti/no dilution, board seats etc). To see an example of how this can end very, very badly for founders and early stage investors alike, read more about how VCs used drag along rights and liquidation preferences in FanDuel.
• The founder decides to not push for an exit and runs the business as a 'lifestyle business'. In some ways this is even worse than a company entering liquidation, as you can't even claim loss relief.

Types of angels

Active vs Passive investors

Active angel investors are those who take an active role in the companies they invest in, often serving as mentors or advisors to the management team. They may provide guidance on strategic planning, help with networking and introductions, and offer valuable industry insights. Active angel investors often have a strong interest in the success of the company and are willing to devote time and resources to help it achieve its goals.

Passive angel investors, on the other hand, are those who provide capital to a company but do not take an active role in its operations. They may simply provide the funds and expect a return on their investment, without getting involved in the day-to-day running of the business. Passive angel investors may not have the same level of expertise or industry knowledge as active investors, and may be less able to offer guidance or support to the management team.

Both active and passive angel investors can be valuable sources of capital for start-up companies, and the right approach will depend on the needs and goals of the business. Some companies may benefit more from the guidance and expertise of an active angel investor, while others may prefer the hands-off approach of a passive investor.

Lead investor

A lead investor is an angel investor who takes the lead in coordinating a group of other angel investors to fund a start-up company. The lead investor may also play a key role in negotiating the terms of the investment, such as the valuation of the company and the ownership stake that will be received in return for the investment.

The lead investor is often one of the largest investors in the round and may also be one of the most active, taking a leading role in the management and oversight of the company. In addition to providing capital, the lead investor may also offer valuable expertise and guidance to the management team. The lead investor may be responsible for bringing other investors on board and may have a significant influence on the direction of the company.

Overall, the lead investor plays a crucial role in the success of a start-up, and it is important for entrepreneurs to carefully consider the lead investor's track record, expertise, and motivations when seeking funding.

A summary of the process of investing

Every investor chooses their own process for making investments, but most will probably look similar to the following:

Your Investment Terms

Our documentation has been carefully crafted to be as SEIS/EIS friendly as possible. Our document offers investors a market standard set of rights and protections. We've also tried to make the paperwork as balanced as possible - neither excessively founder or investor friendly.

That said, if you are in any doubt, you should seek independent legal guidance and tax advice covering your potential investment.

We issue 11 different document types within a standard funding round - you can read much more about the purpose of each of these documents in another article.

We cover what 'normal' terms look like in the article on Avoiding toxic term sheets too.

Regarding liquidation preferences / no-dilution / anti-dilution

Those terms aren’t compatible with the SEIS or EIS schemes, so you need to pick either the great tax breaks offered by SEIS/EIS or these terms.

Please remember that you will have preemption rights in your investment - this gives you the right but not obligation to maintain your shareholding through further funding rounds. You will need to subscribe for further rounds at the prevailing share price to do this, however it does protect you against being diluted if you don't want to.

Our strong suggestion to founders is to reject the use of those terms in any event – they aren’t market standard in early stage investments and can create serious problems when raising later rounds.

Documents used in a funding round

The paperwork you will see and (in some cases need to sign) will vary depending on whether this is a first, or further funding round. For a first funding round you will just be asked to sign two documents as an investor, the Subscription and Shareholders' Agreement (SSA) and the disclosure letter.

We have an article which walks through every document used in a funding round and brings to life the purpose.

Other ways of investing

We cover the 'normal' funding rounds offered on FounderCatalyst in another article, however the investee may offer you the opportunity to invest via a number of different routes - we explore these below:

Via a Advance Subscription Agreement

Currently we don't implement Advance Subscription Agreements on the FounderCatalyst platform (we aren't a fan of them at all from an investors perspective, however we do offer an SEIS/EIS compatible document template for free.

An advance subscription agreement can be compatible with SEIS/EIS if you follow HMRC's guidance

Via a Convertible Loan Note

Convertible Loan Notes (CLNs for short) are very popular in the US but much less so in the UK. Primarily, this is because they are not compatible at all with SEIS/EIS - so if you want the tax breaks of these schemes, you should look at using a different mechanism.

A Convertible Loan Note is a debt instrument that may convert to equity at some point in the future. Some CLNs have to convert to equity at some point, others can be either converted to equity or the loan repaid, at the choice of the investor.

CLNs typically attract interest payments from the company and when the CLN turns into equity, this is usually at a discount to the round price at that time.

Via a SAFE Note

SAFE notes (SAFE stands for: simple agreement for future equity) are an alternative to ASAs and convertible loan notes. They are very common in the US, having been created by Y Combinator in 2013. The SAFE allows the investor to buy shares in a future funding round.

The standard SAFE is not compatible with SEIS/EIS (due to the lack of longstop date and the default position that investors receive preferred rather than ordinary shares) and they are rarely seen in the UK.

Building a portfolio

If you are relatively new to angel investing it is important to understand why building a portfolio of investments can optimise your investing outcome.

Aligning your investments and ethics

Some people believe strongly in investing with a certain ethos. This could include only investing in:

1. Businesses that focus on renewable energy or other 'green' causes.
2. Companies with diverse founders.
3. Companies that meet non-commercial criteria - commonly known as Environmental, Social, and Governance (or ESG for short).
4. Companies that have signed up to B Corp

Conversely, an investor may wish to avoid specific sectors that don't align with their values - common examples are: gambling, alcohol, drugs, tobacco, and anything to do with fossil fuels are common examples.

How to invest with FounderCatalyst

We have a handy video walking through the process of joining a funding round on FounderCatalyst, but the following chart summarises the process:

First, a founder of the potential investee will invite you to FounderCatalyst when the time is right. You will receive an email inviting you to create an account on the FounderCatalyst platform.

Accept our invite and create a password on the platform:

When you first log in, you'll be asked to agree to our terms and conditions.

We'll then ask for more details about you, including your full address. We require your address to include in the investment documentation.

On the next screen we'll ask you to either enter or upload a signature to the platform. We'll put this signature on documents when you agree to sign. We will only ever sign a document with this signature when you re-enter your password when prompted - this ensures it's really you authorising the signing.

We'll then ask you to sign three documents in turn. The first is a mutual NDA - this ensures confidentiality between you and the startup. Next, you identify your investor type, which must be either: High Net Worth Individual Investor or Self-certified sophisticated investor. You need to fit into one of these categories or you shouldn't be investing at this stage. Once you select the appropriate investor type you'll be presented with a declaration in a form prescribed by the Financial Conduct Authority. Finally, we'll show you the Term Sheet for the proposed investment for signing. If you have any queries about the details presented, contact the founder to discuss.

Once you have signed the term sheet you are taken to the Data Room. Within the Data Room you can see all of the documentation we've produced for the funding round plus any content that the founder has uploaded, such as the pitch deck, forecast, proof of SEIS/EIS advance assurance and so on.

The Data Room is structured into folders and then files within those. Click on a folder to navigate into it and see the contents. Click on any individual file to download and view it.

It is likely at this point that the funding round will not be closed for signing and therefore there is nothing for you to do at this stage.

You will receive an email when the documents are locked for signing. When you login to the FounderCatalyst again you will see an indication to the top left of the platform showing that you have documents ready to sign:

When you click on the 'Sign my documents' item, you will be offered a final opportunity to review the documents as follows. Once you are comfortable, select the documents you wish to sign, enter your password and click 'Sign documents'.

You will be emailed again when it is time to transfer the funds to the company. The money should be sent to the bank details in section 4.2(a) of the Subscription and Shareholders Agreement. The amount to be transferred is detailed in Schedule 2 - Part 3 of the same document.

Once the funding round has fully closed you will be emailed a copy of a share certificate covering this investment. The share certificate will look similar to the following:

What happens post-investment?

The founder has some housekeeping to do. This will take some time, so please be patient.

If your investment was under the SEIS or EIS scheme then, in due course, the founders will provide an SEIS3 or EIS3 form. This is your key to claiming tax relief from HMRC, which you can claim via your next tax return or right now. Growth Capital Ventures have a great article on undertaking this task.

Your ongoing relationship with the start-up

We’ve provided some guidance on what founders should do to maintain a healthy founder / investor relationship post investment here and here.

Future funding rounds...and dilution

Whilst it's not certain that your investee will seek further funding, it's fairly common for them to do so. We've got a handy CapTable modelling tool that allows you to understand the impact of later funding rounds on your investment. The following chart shows a typical funding journey:

And in turn, the impact on founders / investors to multiple funding rounds can be seen in this sample model:

Depending on the terms used in a previous round, investors may be asked for involvement in a number of ways. Below, we cover what this means for investors in practice, but we also provide a more detailed article covering the founder perspective, too.

1. Pre-emption rights. Founders will ask you if you wish to participate in future rounds under the same commercial terms as new investment is made. This process allows you to maintain your current ownership percentage by buying more shares. More on this below.
2. Shareholder resolutions. This document provides shareholder authority to the Board to issue the new shares under UK company law. These resolutions need to be signed by the holders of at least 75% of the shares in your company.
3. Investor Majority Consent. If the initial funding round did include investor consents, this letter, produced by the FounderCatalyst platform, requires the consent of holder(s) of more than 50% of all shares held by existing “Investors” before the founder can undertake a number of actions, including issuing new shares as part of a funding round.

All initial funding rounds undertaken on the FounderCatalyst follow an identical process to ensure that the startup has all of the legal paperwork required in place, such as the obvious 'material' documents (the shareholders agreement and articles of association) and the supporting documentation, including an IP assignment and founder service agreements.

Later funding rounds come in different flavours on FounderCatalyst. We explore the alternatives in more depth in another article.

To participate or not?

As detailed in the last section, the process of allotting new shares as part of another funding round naturally reduces your percentage ownership in the business. In fact, this process 'dilutes' all existing shareholders' ownership percentage pro-rata.

Preemption rights give you the right (but not obligation!) to invest in the new funding round on the same commercial terms as new investors.

If the company's trajectory looks great, you have faith in the future, you have more cash to invest (and tax to offset any investment against) you may choose to take up your pre-emption rights and invest more. This investment can be capped at the number of shares required to maintain your current ownership %, however founders will sometimes let you invest more.

If the company is not progressing as you'd like, if you'd like to diversify your portfolio, or you don't have the cash spare (or tax to offset your investment) then you can sit out this round. This doesn't mean you can't take preemption rights in future rounds, but it does mean that your % ownership will reduce.

Whether to participate or not is a very personal choice - some investors love showing their support for founders by reinvesting, others prefer to spread their investments across as many companies as possible and therefore rarely / never invest in the same company twice. There is no right answer, it's all down to your personal preference and circumstances.

Further resources

• If you are interested in learning more about angel investing then Open Angel is an amazing free resource, with lots of accessible video content and helpful resources.