“Yes, we would like to invest”. The magic words that any startup owner loves to hear. Your idea is no longer just a seed in the back of your mind; it is about to be watered allowing it to blossom into the reality you always knew it could be.
After the celebratory high fives and handshakes followed by the compulsory boozy lunch with your new best ‘investor’ friend, a term sheet or funding agreement arrives to formalise your relationship.
The agreement is rather lengthy and contains some legal jargon; defining exactly when is the last day of the month, is important. Other than that it seems pretty straight forward. I mean how complicated can it be, you give us money, I work hard, and we skip and dance together while we share in the super profits, right?
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Wrong!
Depending on the investor, these agreements often contain many potholes which as a business owner you may miss. Funding may not be your game while investors employ some of the brightest people I know who spend hours creating and looking at funding relationships.
So, without getting into every specific legal detail, here are my “6 watch outs before putting pen to paper with an investor”.
1. Hot girl syndrome
The girl who knows no boy will ever break up with her because she is hot or as I like to call it “hot girl syndrome”. She continually pushes the boundaries of her relationship knowing it will have no repercussion. Investors often play to this character, knowing that you will never leave them because they have the cash. Just remember that this is a two way relationship and you can stand up for what you feel is important to you. If your idea is good enough you have just as much leverage as they do, so back yourself.
2. One night stand
We have all had those romances when someone comes into our lives in a whirlwind of emotion and next minute they are gone and we are left to pick up the pieces. Beware of exit terms and strategies that allow for investors to do the same to your business. A good investor will be there for the long term and work with you to build your business.
3. Unrealistic expectations
“Tell him he’s dreaming” is one of my favourite lines from an Australian comedy, The Castle, and is suitably apt when looking at the goals set by the investor. That’s right goals. It is your business but investors are going to manage you on performance measures which they will set. These measures will be based on goals which their business is being asked to meet based on expectations of their shareholders. Remember an investor needs more cash to make more investments. So to attract more clients they will want to show investments which show great results as quickly as possible. Ask yourself honestly what is achievable and beware of investor goals that are outside of this scope as this will result in penalties for you down the line.
4. Unfair relationship
This is my favourite. I give the cash and I get 50% of the profits and I then want my cash back after a certain time. You do the work and you get 50% of the profits. That is fair and how it works? Wrong again. What about your time where you don’t earn a market related salary for your services? As a business owner you need to separate between investment and investment risk. The cash an investor gives you is their investment. The equity share they receive is for the risk that they might not get that money back.
The higher the risk the higher the percentage they receive. Your investment is your time and expertise which generated and brings your idea to life. Your equity share is for the risk that you will not earn your time back. So, when an investor asks for a repayment of their cash investment after a certain period, politely ask them for a repayment of the difference between the salary you took from the startup and what your market related salary is. Then the relationship is fair.
5. Structured relationship terms
What if I told you that I would buy your car but could only pay you in three payments of which each are two years apart? You would charge me interest or a premium on the price for allowing me that, wouldn’t you? So why is it that when an investor says we will offer to give you cash but only commit to it in tranche payments that as business owners we don’t charge a premium or adjust their share in the business?
The reality is by committing to money in tranche payments investors are in fact reducing their risk. Even though they have committed to funding they are only at risk of losing the portion that they have actually invested. The correct basis is to value the business at each stage they are deciding to commit funds and let this determine their share rather than giving a share based on money they promise at day one.
6. We always do what you want to do
Investors love to proclaim that they always let the business owner manage their business and will never take more than 50% of the shares in a company. Don’t let the fact that you have more than 50% of the business shares fool you into thinking the decision or business lies with you. Shares can have different voting or dividend rights depending on the class of type of share. Make sure you are aware of these before putting pen to paper.
