Legal Protections for Early Stage Investors

So you’re new to startup investing, or just thinking about whether you should use an LLC or invest directly. In this post, we’ll share our thinking on why we use an LLC for our investments.

In short, the most important benefit of using an LLC for an individual investor is limitation of liability.

Generally speaking, angel investors are not personally liable for debts or other liabilities incurred by a company they invest in. However, depending on the jurisdiction, there may be certain exceptions to this rule. And while we always vet our founding teams for morals and strength of character, sometimes things go off the rails with early-stage startups. With many gray areas in cybersecurity (as all modern industries), it’s important to have a plan in place for your liability.

Here are some ways that liability can bite angel investors.

In the United States, investors may be held personally liable if they have provided financial advice or other services to the company.
Some jurisdictions may require companies to register with their local securities commission prior to selling securities to investors. Failing to adhere to these rules can result in significant financial penalties and other sanctions - This is especially critical if the investor takes a board seat (see next bullet).
Advancement of expenses - Since most startups have limited cash, indemnification protection against a large damage award is usually pie in the sky. While venture capital board designees frequently have a backstop indemnity from a well-heeled fund, angels who accept a board seat will usually need to shoulder the startup’s credit risk in this context.

As always, do your research on the team, timing, and traction of startups before investing, and ping us if we can help guide through the early stages.