FAO: Wholesale Angel Investors

I can’t publically talk about this because of a Non Disclosure Agreement (NDA), but if you are a wholesaler investor looking to drop at least $10,000 into an angel investment, head over to Snowball Effect and ask to speak to “Jack” (There isn’t anyone there by that name, that’s just my fun code to give you a clue about the privately listed investment that I think you may wish to check out… So don’t actually ask to speak to Jack because they’ll think you’re a crazy person).

You’ll have to be quick because the capital raise is almost fully subscribed.

This will be my first angel investment of the year, and my 5th to date. I had planned to put my angel investmenting on hold in favour of stock market investing because I enjoy the liquidity, returns and surety offered by access to historic data on the stock market. That said, this investment was too attractive not to have a small nibble of.

Business Investing

Why Do Private Companies Sell For Less Than Listed Companies?

As an Angel Investor one of the most common hurdles I see private companies struggling with when trying to raise capital is valuing their business. Specifically, company owners tend to have a disconnect between what they think the company is worth verses what investors are willing to pay.

Too many times I see the valuation set at what the value of the company will be after growth, which leaves no profit in the future for any investor with the risk of losses if the company doesn’t succeed.

I also see valuations being set based on what the owner feels like it’s worth, with no financial justification.

I also see valuations from accountants which are typically based on a DCF methodology. While a DCF is a valid way to calculate a business’s worth, it’s more used to calculate the value in a business rather than the market value, or what somebody would actually pay for a company. This is because it doesn’t leave any room for profit for the investor in the short / medium term, and the discounted rate doesn’t reflect the opportunity cost from an investor’s perspective. An accountant would typically not be in a position to negotiate the level of risk and will typically accept the level of risk given to them by the company owner, giving a more minor discount value.

Finally this brings me to the last type of valuation I see, which is a comparables market valuation. As company owners typically don’t have access to sale data of private companies, they often compare their business to those listed on the stock market. Which brings me to the subject of the article…

Why Do Private Companies Sell For Less Than Publicly Listed Companies?

It seems fair that similar companies should be priced similarly, right? Yet you’ll never get the same price for your company selling it privately than you would selling it publically. The answer to the titular question lies not just in the benefit of liquidity of listing a company, but also in the public nature of listed companies.

When buying a private company, there is a much larger risk premium to overcome due to the fact that there is less data available about the company, that data has not been held to the same public rigor (or sometimes laws) that a public company has. There are also years of documented performance forecasts that can be contrasted against their following year’s results to determine their accuracy, and of course a bunch of laws that must be adhered to in order to fit with the bourse’s requirements, which are perpetually scrutinized by large institutional investors with a copacetic interest to any smaller investor – safeguarding demand. All of which contributes to a lower risk premium for public companies.

There are also aspects of demand that push up the share price of public companies, as not only are such companies easier to buy into, but some institutions may have to buy those stocks to fit allocation requirements.

The benefit of liquidity is also seen in the opportunity for exit. In other words, as public companies are easy to sell, investors don’t need to worry about finding a buyer. This brings supply side pressure on the price of non-listed companies, pushing the share price down.

The nature of sale of private companies also comes with problems, in that any buyer is likely to buy the company in its entirety. This changes the calculation on how much a company is worth, because it’s no longer a silent investment that pays you regular dividends, it’s a job for someone to get their money from the company. Consequently, an investor of a public company might be happy with a 5% dividend because it’s better than the return from the bank, but an owner operator doesn’t want to buy a business, then work all day for the same amount of money they would get from putting their money in the bank.

Finally, there are additional risks and costs related to investing in private companies. For example, one might spend anything from 2 to 30 days researching the company and going through legal processes, incurring costs of thousands of dollars just to make the purchase of the shares.

All of the above make angel investing and owner-operator company purchases less attractive, which makes private companies sell for less than publicly listed companies.


Suitefiles Capital Raise

Back at the end of 2018, Suitefiles Limited successfully raised $1m via Snowball Effect, of which I was one of the lead investors. This money was used to fund additional growth, which has seen ARR go from $0.9m (at the point the original IM was put together in December[?] 2018) to over $1.4m (at the time of writing this article). Suitefiles is now doing another CR to fund more growth, again via Snowball Effect. I believe that this offer will become open to the public in May.

The reason I invested in Suitefiles was because I like the ARR model, I like the management, and I like the fact that they have a niche product in a large market. Finally, I liked the valuation because although it was expensive for a private company, it was cheap compared to the multiples of ARR used to value companies on the stock market.

I won’t provide any analysis on this investment because it’s a private company and obviously I have a conflict of interest, but if you’re interested, head over to Snowball Effect to get more information on investing in Suitefiles.


Legal Matters: Should I Become A Company Director?

As an Angel Investor, there are always opportunities to become a director, and this is a very attractive proposition. You get to have influence over your investment, which is both fun and protects your investment to some degree because you can influence the thinking at the board meeting.

There are however, downsides to becoming a director, especially in early stage companies. Directors are personally financially and legally responsible for the actions of the company. This means that if the company becomes insolvent and the company owes money, the directors will be chased by the debt collectors. This is a particular problem if you are an angel investor in the company, for two reasons:

  • You probably won’t have enough of an investment to control the decisions of the board
  • As an investor, you’ll probably have more equity than the other board members (otherwise why else would they have sought equity at the cost of losing some of their business?)

This means that if the company becomes insolvent, debt collectors will probably come after you first, as they always chase the director who is most likely able to pay. This will be particularly frustrating because the board can make decisions that are against your will because you do not represent the voting majority of the board.

Secondly, directors are responsible legally. This means that even if the board acts against your advice as a director, you are still legally responsible for the company’s actions.

Finally, did you know that you can be a director without being a director? For example, if there is a sufficient paper trail to prove that you’ve been acting as a company Director without being on the board or registered as a director in the Companies Office, you can be held responsible as a director if things go South.

Before taking the position as a director, I recommend looking at the company’s financials to make sure there are no liabilities of concern and things are tracking in the right direction. I also recommend considering the risks of existing contracts that might factor in. You might do some Google searches and check the DRO and insolvency registers on the other directors, large shareholders and any shareholders that may be related to any of the directors. You might also take a look at Prover to take a punt a what level of equity other directors have, in case of the event of company insolvency. You might also want to look at directors insurance and consider getting a list of warrants from the company for more certainty around things, such as if any PAYE is owed or other undisclosed liabilities. I’ll start to build a list of warrants at the end of this article.

I hope that helps someone decide whether they want to accept an offer to become a director. Obviously their a positive points that I’ve not listed, but these are the catches that I think might be useful.


A Checklist For Angel Investors

This article provides a checklist for Angel Investors prior to investing in a company. It’s a list of documents you’ll need and things you’ll need to check before buying shares in a private company.

  • Business Plan – This should include a SWOT analysis, Risk Analysis with mitigation if possible, forecast (with solid justification for the numbers), information about any planned future capital raises, and a plan for how they’re going to spend the money. There are some good Business Plan templates on the internet for this.
  • Exit plan – which should be a conversation about each directors intentions.
  • Evidence of the things in the Information Memorandum (IM) or business plan, such as a copy of contracts to prove ongoing sales.
  • Financials for the past few years (which you’ll need for the valuation).
  • Financial Models – I like to see that a company has done some financial modelling to show that they’ve can justify their decision to seek funding from an investor. They should have modelled the projection of the business without investment, with other types of investment, etc. It should be obvious to you why they’re willing to give up part of their precious business rather than just take a bank loan.
  • A Company Constitution – You’ll want to have a commercial lawyer check this after you’ve checked it. Getting a good lawyer is very important. All lawyers say that they do commercial law, but the fact is most are only good at family law. It’s very important that you get a lawyer that specializes in commercial law – which usually means hiring a big law firm.
  • A Shareholders Agreement – Again, you’ll want to have a commercial lawyer check this after you’ve checked it.
  • Valuation – The company will likely have their own idea of the value of the company. You’ll need to do your own valuation to ensure that you can see value (and the right ROI) of your investment in the company. You’ll need to be able to justify this to the investor if you want to negotiate on the price.
  • Check the Companies Register for existing ownership structure, company history, and search each director and shareholder to ensure that they don’t have a conflict of interest.
  • Check the Insolvency and DRO Register to see if any of the directors have a history there. You may wish to give the director a change to talk about the reason they are listed on the register before walking away from the investment.
  • Check the LINZ database to ensure that the addresses of the directors matches that of the NZ companies database and also get clues about their financial position from dates of mortgages registered against the property title. I recommend using Prover for this, as property data in NZ is complicated, and I believe that this company does the best job of assembling this data into a useful tool.
  • Check the ID (Drivers License / Passport) of the person that you are dealing with to ensure that they are who they say they are, and are listed on the Companies Register as a director.
  • View the Directors Resolution.
  • Search for the directors, shareholders and company on Google and social media websites and read up as much as you can.
  • Ensure that the Shareholders Agreement or other legal document ensures that IP is owned by the company, and new IP that is relevant to the business, which is created by the directors of the company is owned by the company. This stuff should all be in the Shareholders Agreement.
  • Get a list of assets owned by the company.
  • Get the following Warrants from the company, if they are relevant: There is no outstanding debt, PAYE is all paid, there are no undeclared convertible notes or other unlisted shareholdings, etc. Your lawyer can help with a list here, as they are likely to have a boiler plate template with a list of warranties – though it’s your responsibility to check these off before the contract stage.