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.
About the Author
He has been the Managing Director of Beowulf Investments [http://home.earthlink.net/~beowulfinvestments/] since 1981 and is the Executive Director of the Global Village Investment Club [http://home.earthlink.net/~beowulfinvestments/globalvillageinvestmentclubwelcome/] You can email Mr. Cate at: Beowulfinvestments@Earthlink.net