Jeffrey Blomberg and Edward Vergara, both partners in the Greenwich, CT office of the international law firm Withers Bergman, discuss some of the advantages of consolidating “angel funds” into a pooled vehicle, including asset protection and tax planning benefits

Here, Jeffrey Blomberg and Edward Vergara, both partners in the Greenwich, CT office of the international law firm Withers Bergman, discuss some of the advantages of consolidating “angel funds” into a pooled vehicle, including asset protection and tax planning benefits. The firm provides legal advice on tax, wealth planning and investment issues faced by family offices and successful individuals.

Investing in start-up and emerging companies has become popular again.  With the unparalleled success seen by Facebook and the successful initial public offerings of LinkedIn and Zillow, the potential returns of early-stage investing have proven attractive. Along with this rebirth has come a desire by many founders to steer clear of venture capital funds and seek capital from angels and other high net worth individuals and families. Historically, angel investors have been viewed as more passive and less intrusive to founders. Today’s angels often bring even more to the table. 

These angels are not simply friends and family who write a check out of a sense of obligation and a hope of success. They are sophisticated investors who bring networks of contacts that both provide a company with additional financing and open doors to additional revenue opportunities. Often, these angels have substantial positions in major organizations as their “day jobs” and invest in emerging companies on the side. They even utilize their day job contacts openly to further their angel investing goals.  In other instances, the investor is a single or multi-family office seeking access to the venture space and early-stage investing.  Since family offices often co-invest with one another, they can represent access to a potential network of investors.

These investments can grow to be sizable in number and value. Consolidating these investments into one “pooled” vehicle can serve many purposes for the investor. An investor might consider creating a fund-like structure to hold angel investments for the following reasons:

·        Asset protection. Negotiating and consummating early-stage investments and subsequently providing services to portfolio companies constitutes a commercial transaction.  Individuals should avoid engaging in commercial transactions without an entity to shield their personal assets from recovery in the event of any dispute or litigation.  There is never a good reason to arm an opposing party with the ability to seize personal assets simply because there is a business dispute.  Investors should form an entity in which to make and pool together investments.  All business dealings can be done either through the pooled vehicle itself (of which the investor will be an officer or manager) or if a limited partnership structure is chosen, through its general partner which is usually a limited liability company (of which the investor is the manager).

·        Credibility. Investing in emerging company deals has become competitive. While founders may shy away from dealing with venture funds for fear of control constraints, they still want to deal with investors who will be supportive of them and their company both financially and strategically. Often, investing through a vehicle (even if not a true venture fund) provides comfort to founders as the perception is that the potential investor does this frequently and thus the risk of expending resources to reach a deal and then finding out that the investor doesn’t have the means to get the financing closed is minimal. For family offices, the pooled vehicle can provide this credibly while still presenting some anonymity if desired.

·        Administrative ease and flexibility. Probably the best reason to pool angel investments into a fund-like structure is the flexibility it affords the investor. From a simple, mechanical standpoint it makes it easier for a husband and wife or other family members to jointly own and hold an investment without having complex titling issues. A married couple can share ownership in the pooled vehicle (in whatever proportion they desire) and the vehicle itself serves as the record and beneficial owner of the securities.  Furthermore, sometimes investors must meet certain suitability standards such as being a “qualified purchaser” (an individual investor with $5 million of investments) to be eligible to make an investment (in particular to invest in certain angel and venture capital funds). Perhaps a parent is a qualified purchaser but a child is not and perhaps the parent would like the child to participate in the investment. Under certain circumstances, the child can own an interest in the pooled vehicle without compromising the entity’s ability to qualify as a QP.  Additionally, pooling the investments together can provide the investor with an asset that may be acceptable collateral to a lender whereby an individual investment might not be sufficient.

·        Estate planning options. Pooled investment vehicles can also prove very useful when it comes to estate planning. Very often companies will impose significant transfer restrictions on their owners, limiting the ability of a senior generation to transfer a promising investment to a younger generation (or more likely an estate planning vehicle for their benefit) before the investment has realized its full value.  The presence of a pooled vehicle often sidesteps this issue by allowing for an indirect transfer of company interests at the level of the pooled vehicle. Transfers of interests in pooled investment vehicles also allow a family to shift a “mix” of angel investments to the next generation without a cash outlay and without sacrificing the family’s ability to remain invested as a unit. Estate planning advantages can be taken a step further by capitalizing the pooled investment vehicle in compliance with tax rules that permit upside growth to be shifted efficiently between generations. These estate planning opportunities are especially relevant in the current gift and estate tax environment, as the lifetime exemption from gift and estate taxes is at an all time high of $5 million for tax years 2011 and 2012.