This is one of those cases where if it sounds too good to be true…(you know the rest). Ok, so what’s the catch?
The UK government has really done the economy proud by introducing the Enterprise Investment Scheme (EIS) and Seed EIS (SEIS) which gives investors generous tax breaks for their troubles.
SEIS is available up to £150k of investment so I’m going to use it in this example. For a £10k investment, the UK tax authority, HMRC, will immediately reimburse the Angel £5k. If things go awry, another 45% tax relief is available on the £5k. So, the investor will get back £7,250 in total. Incredible.
All entrepreneurs are looking for “smart” money. That is, Angels with relevant experience, connections, and value-adds during Board meetings. So how much is that worth? Well, Dark Angels believe it’s worth anywhere north of £1k per each monthly Board meeting. Ouch. Light Angels might suggest somewhere in the region of 0.5% to 2% in equity options that only vests at exit. Hooray, alignment.
So, what game are the Dark Angels are playing? You guessed it. They could be running their very own parasitic business on the back of your start-up. By month 5, they’ve already broken even on their investment.
Let’s assume you’ve cottoned-on at this stage and the business is struggling so you cut fees. Suffice to say that the mood of your Dark Angel is going to go down like a lead balloon. Presuming the Dark Angel is on your Board, the business is now in a very dangerous position because not only is your Dark Angel disgruntled but they might be incentivised to make the company fail.
Looking at the numbers, that’s £10k invested. Initial tax relief of £5k. Director’s fees of £5k (ignoring tax). Potential tax relief upside of £2,250 if the company fails. If that’s in month 6, then that's £10k invested and £12.25k returned. Which is 22.5% return or 45% APR. Impressive.
The travesty of it all is that the business may not have made any revenue, let alone profit or had any positive impact on society.
So how do you protect yourself:
- Reference Angels before accepting money.
- Be weary of an Angel who doesn’t scrutinise your business properly.
- Only ever offer to pay director’s expenses for Angel investors unless there are extenuating circumstances.
- Options should always have a long vesting period.
In Summary. Contrary to advice you might receive when you’re on death’s door, this is one time that you should gravitate towards the Light (Angels)!
Anyone keen to share their similar story?
Be careful out there,
Alex @ The Tippy Top
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