Escrow - The Insurance for Angels
Escrow - The Insurance for Angels By William Cate
Anyone who invests in any speculative venture that lacks a
business plan will lose his money. After carefully reading the
company's business plan, anyone who doesn't demand structural
changes in the offer will probably lose all of his money. One of
the essential structural changes in the business plan should be
that the investor's money is escrowed until the company raises
the needed funds.
One Investor To The Next
Many startup company promoters live from one investor to the
next. In essence the first investor pays the costs of finding
the second investor and so on. At no time is it possible to
implement the company's business plan because the company will
never have the money to fund it. Let's assume that the business
plan requires $2 million to fund. The promoter can only find two
investors a year to risk money in the venture. Without the
escrow clause, the promoter can live off the $200,000/year
employed finding the needed two investors for the following
year. In 10 years, the promoter has raised the two million
dollars and may have $10,000 in the bank for the project. Of
course, the promoter has lived well on the investors' money for
the decade, but the investors have nothing for their money.
Escrowing your risk capital ensures that the promoter isn't
living off of it. Also, it tends to encourage the promoter to
find the needed investors quickly, since he or she can't access
the money without raising all the needed funds.
A Simple Escrow Agreement
This type of escrow agreement is simple. Your money and that of
other investors can't be released until the Escrow Account has
the specified funding required by the company's business plan.
The Escrow Agreement has a fixed date upon which the Escrow will
end. It's usually a year or two after the Escrow account is
setup. On that date, you and any other investors will get your
principle refunded in full if the account hasn't reached its
funding goal.
Total Loss Protection
There is a second escrow agreement that will protect you against
a total loss of your risk capital should the company's business
plan start to falter. The basic claim in any well-written
business plan is that the company will do this and something
positive will result. Then, the company will do the next thing
and something positive will result. There should be at least
five of these phased events outlined in a good business plan.
A wise investment group uses an Escrow Agreement to tie their
funding of the company to the projected positive results in the
company's business plan. The business plan states that it will
take X dollars to achieve the results projected in Phase 1 of
the business plan. Once the money is raised, the escrow agent
releases to the company the funds required to achieve Phase 1.
Assuming Phase 1 results are as expected, the Escrow Agent
releases the money for Phase 2 and so on until the money is
expended and the Startup Company becomes operational. If the
promoter fails to achieve any phase, the investors can either
terminate the funding agreement or decide to go forward. This
escrow formula gives the investors insurance against a potential
total loss of their risk capital.
Choose Your Escrow Agent Carefully
Who should be your Escrow Agent? Usually licensed attorneys and
Certified Public Accountants are your most cost-effective
solutions. Be certain that the Escrow Agent has Errors &
Omission Insurance. It protects you against an Escrow Agent
mistake. Banks also usually offer escrow services, but at rates
that are often prohibitive.
If you give your money away without insurance, don't expect to
get any of it returned to you.