Angel groups fees - 3) Carried interest

Lastly, carried interest. For those unfamiliar with the concept, it is essentially a share of the profits from investments – in this case, the (long-term) capital gain from successful investments in early stage companies.

(This isn’t the place for a discussion about the philosophy of carried interest. Let’s just say we don’t subscribe to the NY Times’ view that it’s an unjust privilege for hedge fund financiers; in the real world, it’s a sensible approach to taxing capital gains which are already lowered by corporate-level tax.)

Our members pay a "carried interest". This means we receive a proportion of the gain on a successful exit. We earn nothing if the investment fails to return more than the total contribution (including the additional contribution we discussed earlier) for the investor. This is why we are doing this, and, we believe, a good “incentive plan” to help our groups make good investments, monitor and assist them thoroughly and consistently, and shepherd them to positive exits.

Is that a large fee?

Well, a typical "alternative asset" fund (like a private equity, hedge fund, venture capital fund, or SBIC fund), charges a 20% carried interest (as part of the “2 and 20 rule”); ours is considerably less than that. The discount is because the success of any investment depends partly on the investors – who make their own investment decisions, contribute to the due diligence efforts, and provide assistance to companies as board members, mentors, or contact-makers. This isn’t the case in most funds, where managers are solely responsible for the success or failure and thus get a 20% interest.

(This gets a bit wonkish, so apologies. It’s also discounted because angel group carry is American style not European style. We have different investors in different deals, so a “fund level” carry isn’t possible. The relative impact of deal-level vs fund-level carry varies depending on the success of the fund. Angelist provides an interesting model to help estimate the impact, and concludes that deal level carry makes a fund-level carry 25% higher (i.e. a 20% deal-level carry is equivalent to a 25% fund-level carry on their assumed "typical" (pretty successful!) fund). We think this is broadly true.)

We don’t think it’s an onerous fee structure, and the 230 members that have invested at least once so far presumably agree.

When the fees are all added up, there is certainly an impact on returns, as there is in other asset classes. Making a couple of small investments doesn’t make much sense when paying an annual membership fee – though for many the education, networking, and intellectual challenge alone is worth the admission price. But if you get a diversified set of investments over a couple of years, these kinds of returns are possible even after fees.

Angel group fees - 2) administrative costs

Following from here, if a member chooses to invest in a deal through our groups, they face two fees.

  1. An “additional contribution” to cover future costs of the investment’s administration
  2. A “carried interest” on a profitable investment outcome

1) We run all investors’ commitments through one “investment entity” (a Delaware Series LLC) which becomes a shareholder of the portfolio company. This is good news for the entrepreneur (one entry on your cap table), for the investor (one Schedule K1 for this year’s investment activity, even if you did 10 deals, at tax time), and for us (one entity to administer, not one separate entity for every investment).

Unfortunately, creating an investment entity costs a surprising amount. Fees include:

  • Filing and formation fee in Delaware ($200)
  • Delaware registered agent fee ($50)
  • A certificate of authority to do business in SC or NC ($110 or $250) plus payment for a DE certificate of good standing ($50) to get that
  • State Securities / Attorneys General filings (the state version of the SEC Form-D) in SC or NC ($300 or 350)
  • Drafting (or recycling) of articles of incorporation and other formation documents, which for the first time might cost $500-$2,000 of attorney’s fees

And keeping it running costs even more:

  • Delaware franchise taxes and annual report ($300 per year)
  • Delaware registered agent fee ($50 / year) ongoing
  • NC annual report ($200 / year) – and an extra $2 for filing it electronically! (SC doesn’t require one of these)
  • Preparing and filing tax returns. Though our sponsors do these as efficiently as possible, it nonetheless costs $3,000-$6,000 per year to prepare the tax returns and provide investors with their Schedule K1s.

Even winding them up costs money - $204 in Delaware plus $10 more for SC!

So over five years, that’s $30,000+ – regardless of how little we invest. Not to mention the time sunk into filing documents, reviewing tax returns, recordkeeping, and firefighting. We get little productive work done in March because of all the tax returns!

The additional contribution we require for an investment is held to pay for these costs (and other direct entity- or investment-related costs) over an estimated investment life of five years. If the additional cash is not used (e.g. if we have a quick exit, or a quick write off), they are refunded to the investor; and if there is a profitable exit, these costs are returned before the calculation of carried interest. (We collect it upfront because we don’t want to run out and therefore need to chase members, some of whom may have left, for $25 each year.)

The operators of the group don’t make money from these contributions. They’re the regressive taxes required to make early stage investments – a tax seemingly on us and our investors, but ultimately the tax burden is on the early stage companies that we are trying to funding. Not obviously the group you should tax if you want a dynamic entrepreneurial economy and "innovation hub", but that’s modern regulatory compliance for you.

2) Carried interest – we’ll tackle that next.

Angel group fees - 1) Membership dues

One of the questions we often get asked by potential members is “how much is this going to cost me”?

Investing always comes with fees. To make angel investments, on your own, through a group or a fund, there are some unavoidable few costs – in cash, time, and opportunity cost.

Any yet it is difficult to find out what angel groups charge, and why. So in the interests of transparency and education, we’re starting a few posts to explain clearly what fees apply and why they are charged.

To join Asheville Angels, members pay an annual membership fee. Why? Dues cover the cost of all operational aspects of the group – from meeting room food and AV, to travel and entrepreneur meetings, to outside technology vendors (pitch video creation and hosting, our flow technology platform (ProSeeder), this website), to everything else that makes monthly meetings for over 200 people run smoothly.

Most importantly, it buys members a professional, full-time team of group managers and staff. This structure is fairly unusual. Angel groups are often member-led, volunteer-led, non-profit-led, or financed by state government largesse. This can work, and often come with lower membership dues – but they can lead to challenges when the volunteers run out of time or interest, or when the financial support lessens.

What do the fees really buy? In exchange for dues, members get access to a proprietary set of well-screened investment opportunities that are otherwise very challenging to access as an “asset class.” They get exposure to new technologies and passionate entrepreneurs, opportunities to network and interact with some of the leading business and community leaders, and the fulfilment of sharing their expertise as mentors to entrepreneurs or board members of portfolio companies. They also get membership of the national Angel Capital Association, free access to the suite of education materials and events about angel investing, and much more. Most importantly, they get the collective insight of 200 other investors to help avoid investing mistakes and benefit fully from the best opportunities.

Once you’ve paid to join and receive these benefits, there is no obligation to do anything else in our groups – no minimum investment requirement, no “service requirement,” no compulsion to be a mentor or board advisor. For those that choose to invest, there are two other sets of fees that we’ll cover in future posts.