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IP considerations for angel investors
23 May 2022
By Peter Finnie, partner and patent attorney at full-service IP law firm Potter Clarkson.
This article was originally published in Angel News.
How angel investors can conduct their own due diligence
Despite being of unwavering, critical importance for early-stage business growth, it seems angel investment is receiving a renaissance. For the first time since 2014, angel investors made more investments in private UK startups than crowdfunders in 2021.
Beauhurst said the angel investment deal count overtaking crowdfunding was due to a combination of increased activity but also more businesses revealing the involvement of their guardian angels. As both patent attorney and an active angel investor, it’s brilliant to see the spotlight shone on the angel community.
Angels are, of course, the first port of call outside of friends and family that founders turn to, making them an invaluable resource to jumpstart ventures. However, from my experience, there’s one barrier to making well informed investments as an angel: conducting your own due diligence.
Do you really know the business you’re funding?
Generally, angels invest in opportunities on the strength of the team and positive track record or because it’s an area they have a personal interest in. They commit £10,000, £20,000, £50,000 or more. The issue here is that the average angel’s research into the company they intend to back can often be at surface level only.
Comparatively, a VC firm has more formal processes in place to dig deep into an investment opportunity to mitigate risk and assess the price, possessing resources for the appointment of lawyers and such to conduct thorough assessments, given the higher volume of capital being invested.
Angel networks find opportunities for members, of course, and are capable of collectively drumming up anything from £500,000 to £1m. But no one individual person is investing enough to undertake significant technical or legal due diligence and even investing as a group does not justify spending money on due diligence – it is all accepted as part of the high risk of these early-stage investments offset of course by generous tax incentives.
In my experience, it isn’t always easy to pool knowledge as an angel investor with co-investors. Some co-investors may understand the venture’s technological background and opportunities thoroughly, but that isn’t shared with me. Likewise, I’ll review the IP position thoroughly but don’t share my analysis with others (not that I always know who they are!). It can be quite a lonely process.
While people may be unfamiliar with IP on a professional level, there are steps that can be taken to better arm yourself during investment pitches that pique your interest to asses the importance and strength of the IP position.
Prior to making an investment, it’s worth remembering that the funding process is a two-way street: the founder is seeking investment, while the angel desires a return on that investment – believing that the venture is worth the risk. With this front of mind, angels should therefore feel comfortable in asking as many questions as necessary to be assured that they’re making the right decision.
Pre-investment, companies will put their best foot forward to ensure they’re pitching the opportunity at its best, although they’re not obligated to tell the investor anything about IP and often don’t. The angel must be prepared for this, which can be done even without significant IP expertise – just by asking the right questions.
Asking things such as: Can you tell me about your patents and what they cover? Where does IP feature in your business plan? Do you own your patents or is it licensed-in? Do you have key trade secrets that underpin the technology? Do you maintain a register of IP assets we can see? How does the IP map to the commercial products? Have you investigated your freedom to operate (FTO)? Depending on the responses you get, the absence of the information tells you something just as much as the availability of answer.
By quizzing founders, investors become empowered. In putting the company on the spot, this will either raise or lower confidence around the IP foundations for their technology and its importance for an exit. This is the very essence of conducting IP due diligence. You don't even need to fully understand the answer – it’s telling if a founder didn't bother to inform you of something upfront or can’t answer the question with ease.
While investing in businesses as an angel can be a solo exercise, there is an approach that can be implemented after funding a firm, either independently or encouraged as a team: request regular company IP updates.
Some founders may seem perturbed by this query, but they shouldn’t be as angels have provided their personal money at high risk. Directors have a duty to shareholders, so while they may elect to withhold information, they're not able to refuse a reasonable request for a progress update and to be kept informed of ongoing IP risks that may affect future funding rounds.
Commonly, updates provided to investors are on the sales pipeline, growth strategies and funding requirements. But in asking for those all-important IP updates, which can simply be packaged up as a quarterly newsletter, angels can then be assured that this key asset type is being managed properly.
By keeping a company on its toes, angels, regardless of their depth of understanding, can recognise that the IP, which likely underpins a company’s value, is secure –or not. Future funding rounds are likely to be led by VC funds, and they will conduct thorough IP due diligence and possibly reset valuations if problems are unearthed at that stage – to the detriment of the angel investors.
With this knowledge, angels can better protect their investment and ensure the continued growth of angel investments on the whole, which can only be a good thing for the continued rise of our community and business growth overall.
This article was originally published in Angel News.