Angel Investing 101: Investment Strategies and LLCs

Introduction to Angel Investing

Angel investing involves providing capital to startups in exchange for equity. It’s a high-risk, high-reward venture that allows investors to be part of a startup’s journey from its inception. Given its risky nature, it’s advised that one should first secure their investments in lower-risk asset classes before venturing into angel investing.

The Role of LLCs in Angel Investing

Investing via an entity like an LLC can provide a structured way to manage investments. LLCs offer liability protection and flexibility, making them an attractive option for angel investors. They allow investors to pool resources, share risks, and potentially simplify the tax implications associated with investment returns. Platforms like doola offer services to streamline the process of forming an LLC, handling back-office paperwork, and ensuring compliance, allowing investors to focus on their investment strategy.

Benefits of LLCs for Angel Investors

• Liability Protection: An LLC can protect personal assets from business-related lawsuits or debts.
• Flexibility and Pass-Through Taxation: LLCs allow for an operating agreement that outlines the structure and rules of the business, offering flexibility in management and profit distribution. Additionally, LLCs benefit from pass-through taxation, avoiding the double taxation faced by C corporations.

Finding Opportunities

Angel investing opportunities can be sourced through personal networks, angel investing platforms, or by joining angel investing groups like Angel Squad (created by Hustle Fund). These platforms and groups offer a structured way to access vetted investment opportunities, learn from experienced investors, and participate in syndicates, reducing the amount of capital required to invest.

Sourcing Deals and Generating Returns

• Building Deal Flow: Become a go-to person for those leaving a common workplace (e.g., Lyft) to start their own companies. Network within university or professional circles to discover investment opportunities.
• Making Your Interest Known: It’s vital to communicate your interest in angel investing to your network, as potential investment opportunities could be overlooked otherwise.
• Return on Investment: Returns are typically realized through an IPO or acquisition of the company you’ve invested in, with a timeline that could extend beyond a decade.
• Investment Amounts and Strategy: For individuals looking to invest smaller amounts (e.g., $1K to $5K checks), diversifying across 20-30 companies is advised due to the high-risk nature of angel investing.
• Expectation Management: Most investments might not yield a return, with the hope being that one or two out of a larger portfolio will provide significant returns.
• Investing with Friends and Communities: Investing doesn’t have to be a solitary activity. Forming an investment group with friends or joining communities like Angel Squad can make the experience more enjoyable and educational.
• Angel Squad as a Resource: Angel Squad offers education on smart investment practices and a community for investors to connect, share interests, and learn from each other. It hosts live investment opportunities discussions, founder meetings, and offers a framework for assessing startups.

Forming a Business: LLC vs. C Corp

• Choosing Between LLC and C Corp: Often, new entrepreneurs believe they should form a C Corp because well-known companies like Airbnb or Uber did. However, for many, forming an LLC is more advantageous due to the pass-through taxation, meaning taxes on profits are paid at the individual level, unlike in a C Corp, which incurs both corporate and individual taxes.
• Self-Employment Tax Advantage: Passive investors, including angel investors, are not subject to self-employment tax, offering a tax advantage.
• LLC Benefits at Exit: An LLC allows members to outline what happens during an exit in the operating agreement, providing clarity and agreements on distributions.

Investing with Friends: Multi-Member LLC

• Pooling Resources: Individuals can pool resources with friends by forming a multi-member LLC, allowing them to invest as a group, which can be especially useful for those who might not have substantial funds to invest individually.
• Process of Setting Up a Multi-Member LLC: The process includes forming the LLC, obtaining an EIN (Employer Identification Number) from the IRS, setting up a business bank account, and then pooling capital in this account for investments. This structure allows for shared ownership and returns on investments.

LLC vs. C Corp for Venture Capital

• Delaware C Corp Requirement: When raising US venture capital, investors often require a Delaware C Corp due to its structure favoring easy equity administration and the legal environment of Delaware.
• Choosing the Best State for LLC Formation: For those living outside the US, Wyoming and Delaware are popular choices due to lower annual fees in Wyoming. For US residents, forming an LLC in the state where they conduct business or reside is usually most advantageous.

LLCs vs. Sole Proprietorships: Liability and Benefits

• Liability Protection: A key difference between an LLC and a sole proprietorship is the liability protection offered by LLCs, providing a separation between personal and business assets.
• Business Entity Benefits: Having a formal business entity can offer various advantages, such as the ability to write off business losses, access to business bank accounts, and eligibility for business credit cards that can provide lucrative points for business expenses.