TiE Talks Podcast 02 | Legalities Of Angel Investing With Karun Cariappa | Investment Insights

In this episode, the host delves into the world of angel investing, exploring the legalities, due diligence process, and exit scenarios for both founders and investors. The conversation begins with a discussion on the documents involved in angel investing, such as non-disclosure agreements and term sheets. 

The importance of due diligence in early-stage startups is highlighted, covering aspects like financial, legal, and leadership due diligence. The rights package for minority investors and angels is also explored, along with available sources of information on rights and documentation. 

The complexities of cross-border investments and the various exit scenarios, including IPOs and strategic sales, are also discussed.

Discussion Points: Legalities of Angel Investing with Karun Cariappa

• Documents to look at when angel investing
• How much due diligence is needed for early stage startups
• Investor rights and protection
• Sources of information about rights and documentation
• Value of legal advice
• Complexities of cross-border investments 
• Legal options in the event of conflict between shareholders
• What are the alternatives to a SAFE for an angel investor?

Transcript: Legalities of Angel Investing with Karun Cariappa

TiE Talks brings to you leadership and venture-building lessons from founders, investors, and experts in the TiE Singapore network, a vibrant eco-system of Asian entrepreneurs, angel investors, venture capitalists, and industry professionals.

Ritu G. Mehrish: Two months back I had a conversation with my father and he said to me he’s 78. And he said you’re doing fine in life. Have you become an angel investor yet? So the reason I tell you this, that everybody who has money or spare money either is an angel investor or wants to become one. And which is good.

Which is good for the ecosystem. But what does it really mean to be an angel investor? And then what are the legalities behind it? A lot of us understand, oh, you invest money in this company, that’s it. But what is the documentation required? What are the legalities? And that’s what we are gonna discover today so I’m really gonna start with Karan’s first question.

Documents to look at when angel investing

Ritu G. Mehrish: What are the documents one should look at when you are investing?

Karan Cariappa: Thank you very much for having me over today. I think from an angel investing perspective there are a number of documents that we look at from a legal perspective. Obviously, if you are a founder, one of the first things that you wanna make sure of is that all your information, your confidential information is actually protected.

So you may have a non-disclosure agreement that you’ll enter into with a potential investor to make sure that none of your proprietary knowledge or information is actually shared with anyone. Obviously, the next one will be a term sheet. There are two types of term sheets. One is a long-form term sheet or a short-form term sheet.

What’s the purpose of having a term sheet? It’s goal setting. It’s to make sure that people understand, the investors understand and you understand what exactly it is that you’re signing up for. And these are, these could be conceptual points that you discuss in your term sheet. I’m a big fan of actually having a detailed long-form term sheet because, from a founder’s perspective, they pay a lot more attention to the deal that they’re trying to strike with investors.

But if time is short, then obviously you need something which is already present. It’s like a cut-and-paste. I don’t want to say, but, because each deal is unique, you want it to be more or less set in the sort of format, in the terms that you want to agree to.

The benefits of doing a term sheet are that you have exclusivity, you have a time period with which people can actually kick the tires of the company, understand whether you want to do this deal or not, and want to do the deal. And then you don’t necessarily need to go out to multiple other partners or other parties to see whether you want to invest or not.

How much due diligence is needed for early stage startups

Ritu G. Mehrish: Oh, I have a follow-up question, especially early-stage investments, how much due diligence does one need to do?

Karan Cariappa: That’s a great question. It’s a question that we get asked all the time. Due diligence is if you’re buying a car, how do you understand whether a car is a good car, suits your purposes, has a great engine, or doesn’t have a great engine, has the right sort of papers, et cetera?

So similar to any sort of investment that you make, you need to look under the hood. You have to understand that you are taking a risk, you’re taking on a risk as an investor.

Yeah. But for you as a founder as well, you need to be able to tell people that, look, I’ve given you everything that I know about the company. And the purpose of due diligence is basically its risk allocation. When an investor comes in, Do they actually appreciate and do they actually know what they’re actually investing into?

What are the sort of pitfalls that the company has had to go through? Have they resolved those pitfalls? Have they not resolved it? How can we cure those pitfalls? So due diligence is an ongoing exercise. There’s. Legal due diligence. There’s financial due diligence, there’s tax diligence, there’s privacy.

Data privacy is such a big factor today that’s also important for you to delve deeper into tax diligence, obviously, because you can’t escape taxes, right? So there are a number of areas that you need to do diligence on for early-stage startups, very early. Obviously, a lot of the corporate governance issues may not already be there, right?

So I think for angel investors, it’s important to diligence the business of the company. What is it that the business, what is it that the business is actually trying to achieve? What is it that they actually have in place? The rest of it obviously can come later. Yeah. As the company grows, it has more people that it can invest in, financial controllers, et cetera, et cetera.

Ritu G. Mehrish: What about leadership due diligence? Do people really do any due diligence on leadership? Of the founder or the founding team? Like to what extent do investors do that or should do that?

Karan Cariappa: Absolutely. I think this is, who are you really investing in? You’re investing in the vision of a founder, so the founders’ antecedents, understanding who they are, and their reputation in the market is also super important. We are finding, even in the legal profession, that a lot of our clients are coming to us and asking us.

We need to do integrity diligence, which is basically understanding who the founders are. Can you help us with that? So I think from a founder’s perspective, You have to adhere to certain norms. Make sure that your reputation in the market is great.

How you treat early-stage investors, if you’ve done previous businesses, is also very important. And obviously your peers, your network, your sort of. Where you worked before, all your sort of experience, all of that will also come to light. So it’s very important. I think, with early-stage investing, it’s the person behind the company that you’re investing in, so it’s very important.

Ritu G. Mehrish: I’m glad you said that because I was just reading some articles and there was a thing about that, how we investors don’t spend, they don’t say, they didn’t say they don’t spend any, but they don’t spend enough time maybe, right? There’s a lot of focus on the Excel spreadsheets, the business model, and all of that.

But that part is probably now may be the time when the focus needs to shift when they’ve seen so many companies fail in that aspect. Absolutely. So I’m glad you said that.

Investor rights and protection

Ritu G. Mehrish: I wanna move on to my next question. What are the typical rights packages that both sides, minority investors or angels should look at? But also from the founder’s perspective?

Karan Cariappa: So the rights package is a mixed bag depending on who is coming in at what point. So if you’re an angel investor, from an angel investor’s perspective, you typically don’t really have too many rights. What you’re doing is you’re putting in a small check into your company and you are, you’re not really looking into how the company is being run.

All that you want is information rights. So the company needs to, or the founders need to actually get back in touch with you maybe on a monthly basis or a quarterly basis, share some financial information with you. Make sure that any big, major sort of decisions that they’re making include, for example, a future fundraising round, or if there’s an acquisition opportunity or if there’s a significant hire, they need to let you know, but there’s nothing much that you can really do about it.

But if you’re a late-stage investor, obviously. Affirmative voting rights are super important. The information that you have with respect to the company, how quickly do they actually send you all the information, financial information, primarily information with respect to customers, anything major that’s happening with the company, that’s important.

The other rights are obviously anti-dilution protections. If there’s a further issuance of shares, how do you actually protect your interests? If there’s an acquisition that happens, are you going to be dragged? Are you going to be tagged? These are rights that you’ll negotiate into the agreement.

But from an angel investor’s perspective, you won’t really get too many rights.

Sources of information about rights and documentation

Ritu G. Mehrish: Where do people typically go to find out more, all the rules and all the things that you’re talking about? Who do they go to apart from coming to you?

Karan Cariappa: I think nowadays you’re finding that there’s a lot of information out available on the net. You’ve got in Singapore, you’ve got Vema, which is a sort of platform where you get a lot of these standard form agreements.

This is basically Singapore lawyers who have gotten together and have created certain forms so that you don’t really need to spend too much time with legal counsel advising you. That also saves costs for everyone. You want to get the deal done very quickly. You can do that in the US, the most evolved market.

You’ve got your venture Capital Association forms. That people use. That’s a very standard form. You’ve got detailed explanations also as to what your liquidation preference rights are, how anti-dilution works, and what your preferential rights ought to be. All of these rights are set out there in very basic language so that everybody can understand.

So there’s a lot of information out there, and people I think, have made a conscious effort. To make sure that both founders, angel investors, people who want to be part of this ecosystem, have all of the information that they require.

Value of legal advice

Ritu G. Mehrish: What I also wanted to ask you is when do people come to you?

Karan Cariappa: People come to me at all stages. They come when they’re at an early stage. So I used to be a mentor at an early-stage incubator in Singapore called JFTI many years ago. So I worked with a lot of the young companies that were set up under that incubator. They came to me every time. They had a little bit of a legal issue with a licensing problem.

They’d be like, do I need to get a license in order to undertake this business in this market? Yes or no. And so I’d be able to help them with basic, legal advice. But of course, the details, the devil always lies in the details, right? So when you are entering into, say, your series A agreements and then later agreements, obviously, that’s when people wanna make sure that their rights are protected.

For founders, for example, their ESOPs. People come and ask us questions as to how we need to structure these ESOPs, right? When they’re an acquisition target. When somebody’s actually contemplating acquiring one of these companies, then you know, the founders wanna make sure that their rights are protected.

Cuz one of the things is that your, yeah, your obligations don’t end upon you completing the deal, right? And taking the money. There are still indemnity obligations, which have a certain tail period, which you need to protect for. So how does a lawyer who understands what investors or acquisition targets are looking for?

How do the lawyers sort of address that? That’s when you need someone who can help manage the deal.

Complexities of cross-border investments

Ritu G. Mehrish: Karan I would assume that they’re probably, the complexity is much more when there are cross-border transactions involved. And I know we probably don’t have too much time, but I would love to hear your thoughts on that.

Karan Cariappa: No, absolutely. Cross border, if you are used to investing in a certain market, you expect that the legalities also should be the same in that particular market. That’s not always the case. For example, Singapore is one of the easier jurisdictions for you to make investments in. You have your exit rights, which are more, set out.

You know that if something were to go wrong, your redress mechanisms are more the rule of law really applies so you know exactly what the outcome will be. In certain other jurisdictions, it’s not so clear-cut. So you need to understand what those risks are when you invest, which again, goes back to my point on due diligence.

Something that may be absolutely legit in a particular jurisdiction may not be legit in another jurisdiction. Data privacy. Each jurisdiction has its own nuances, its own, evolving area of law. So as a result, you need to be, you need to make sure that you’ve got the right experts for that particular jurisdiction.

Who will be able to help? So that’s one of the sorts of pitfalls, the other movement of money, yeah. Investing in a jurisdiction that has got capital control, such as India, for example, has got various rules, and regulations that you need to comply with. So debt, for example, as you as an investor putting debt into an Indian company, it may or may not fit in with what the external commercial borrowing guidelines are, which is, India’s Reserve Bank of India, India’s sort of central bank, sets out where you can actually put debt.

So all of these factors are issues that you need to consider. Make sure you’ve got the right advice when you walk into any particular jurisdiction because it’s a complex world out there.

Ritu G. Mehrish: I can only imagine. So last question before we ask the audience for questions. What are the exit scenarios for founders as well as for investors? Angels?

Karan Cariappa: The most popular one obviously is IPOs or SPACs when SPACs we’re going crazy a couple of years ago. The other is strategic sales, obviously. I gave an example of an acquisition target coming in, looking to acquire you. Founders exit, and investors exit. Everybody’s happy, everybody walks away.

You’ve got great money. Obviously, the Ipo, the founders still want to be there. They still want to run the company, and an IPO is a significant exit for them. Listing on stock exchanges anywhere in the world is quite a significant event for founders and for the company as a whole. Any sort of acquisition that comes even if you want to look to buy a minority stake.

Maybe it may trigger your tag along or drag along, right? So all of these things could get triggered. So these are your typical exit scenarios. These are great exit scenarios. I don’t want to talk about the downside exit scenarios because that’s maybe for another time. But these are the sort of exits that you would be looking for in your agreements.

Ritu G. Mehrish: Great. Thank you so much, Karan. Like me, I don’t understand the legalities, but I understood at least a bit of it today. Thank you. Any questions from the audience?

Legal options in the event of conflict between shareholders

Audience Member: in the context of Singapore, if there is a conflict between two shareholders, And one of them refuses to sign the transfer. What legal options do you have?

Karan Cariappa: So if they’re founding partners, there must be a dispute redressal mechanism that you have.

Where you notify them saying that, look, I’ve reached out to you. You need to sign this transfer form. You’ve not done so, and you’ve not responded to any of my messages, emails, et cetera, et cetera. You need to build a case, a defensible case in the event that he goes to a court of law or he goes to arbitration and he says, look, I wasn’t informed.

I did not know. I didn’t want to give my permission, et cetera. So all of these will be built into your agreement. It’s something that you’ll have to make sure you provide for. Where you either, if he’s non-responsive, you have the ability to buy him out or force him to basically sell to you

Audience Member: I was having a dinner chat with someone who runs an angel network in India, and we were talking about how usually at the series A stage, a lot of the initial angel investors especially get wiped out. And there were two arguments largely on the table, which is one is they have taken the risk to invest so early on, and so you’re expecting an amazing multiple, right?

That’s one perspective. The other perspective is when a series A investor comes on board at that stage, you want advice on growing and scaling. And the value of that angel investor isn’t as great. And so I just wanna know what your perspective is between these two and what have you seen is better for startups as a founder?

Karan Cariappa: It’s different strokes for different folks, right? So if you think that the angel investors have been with you for a number of years and they still continue to have faith in you, and they’re looking for ultimate upside, so they don’t need an exit scenario at your series A level, they want an exit scenario at a much later stage.

Then who are you to deprive them of that opportunity? They’ve helped you grow to a certain level. And then, if they wanna see that upside until you IPO or there’s a significant strategic sale, then you know, that’s something that they’re entitled to. Your agreements will provide for that.

Obviously, if you want to go and convince them otherwise, then that’s up to you. I do know that it’s easier for a brand new investor to deal with a simple, simplified capital table. So that means you have fewer people that you need to interact with. So you need to factor that into your mind.

Maybe at a later stage, you can take all your angel investors, you can create an SPV or a pool, and you say that, look, you guys sit in this pool. All the decisions will come from that pool via consensus, like a basis. And you will then be this pool entity, this SPV will then be the shareholder on my cap table, so everybody will get their pro radar, right?

Sort of addressed. In that manner. So there are various ways for you to structure this. It’s obviously a lot of dialogue that you need to have with your angel investors as well. And we enable what the founders want, and what the investors want, and we can always provide for it.

What are the alternatives to a SAFE for an angel investor?

Audience Member: Question on the safe document. Do you feel that is protecting enough or giving enough rights to an angel investor? Because effectively you don’t exactly get any real, deadline date, value, or anything really out of it?

It really is contingent on a significant future event happening. So what are the other alternatives that an angel investor might explore?

Karan Cariappa: Great question. I think this is one of the issues with angel investing is that your risk appetite has to be high, right? Because these are fledgling companies, they’re not fully set out.

There isn’t publicly available information. You probably aren’t even doing any diligence on these companies. You’ve met the founder. The founder comes and tells you, look, I’ve got this great company. I think it’s gonna have great guns. You will make a significant amount of investment and you’re like convinced you have 1, 2, 3, 4, whatever, even 10 meetings, right?

It’s and then you say you know what? I’m comfortable when you put in money as an angel investor, you have to be able to walk away from that money also. That’s said to be a safe agreement. Always has a maturity date. It says that it’s basically a debt that converts into equity at a future event, right?

You will have an interest component in your safe agreement, and you will also have a maturity date in your safe agreement. The maturity date will be like if you have not been able to undertake this future fundraising event by a certain period of time, then I should be entitled to get my money back with interest. That’s what the agreements provide for. Now, whether you as an investor can go and enforce that is a different question because, by this point, the companies probably run out of funds. They don’t really have any money. There’s no personal liability that’s been imposed on the founders themselves.

So your risk appetite, like I said, needs to be super high for you to be able to take that hit.

Our Guests: Legalities of Angel Investing with Karun Cariappa

Karun Cariappa is a Partner in the Corporate and Commercial practice group in the Singapore office.  Prior to joining the Firm, Karun was a consultant at Fernbank Holdings (Singapore).

Karun has a multi-disciplinary practice, including capital markets, venture capital, and tech-related investments and acquisitions and related corporate matters. Additionally, he has advised corporate clients, investment banks, selling shareholders, and sponsors on a wide range of capital markets transactions.  

He brings significant experience and relationships across both Hong Kong and Singapore, where he has been based for a number of years. Prior to joining the Firm, Karun was a Partner and global co-head of the India practice at Morgan Lewis in Singapore.