March 25, 2015
Raising money from informal investors can seem easier than gaining venture capital financing for your startup at early stages. It is indeed on many points, yet when it comes to signing the initial agreement, make sure the whole process is as formal as possible with all the terms covered and reviewed by attorneys from both sides.
Typically, the terms you’ve settled on in your first round set the stage for later rounds. Thus giving away too much could backfire for your business. Here are five tips on how you can make the most out of your financing deal with informal investors whether they are an angel group or your friends or relatives.
1. Don’t give up pro-rata rights to your first investors
Pro-rata rights secure them a right to maintain ownership in the company through the next investment rounds. The thing is, all the other future investors would probably want to receive the same rights even though they haven’t considered it before. You’ll have to balance the needs of your early investors for the sake of sustaining your company attractiveness for the later institutional investors. Providing these right could hurt your business success.
2. Restrict your share restrictions
On early stages of raising capital from informal investors, restrictions on the sale of shares owned by the founders are never imposed. Typically, they are added to retain initial team and founders during the venture capital rounds of financing when it is critical to have everyone in place to make the deal work.
However, recent trends show that more angel investors now request these restrictions during the early rounds. Agreeing to this may not be your best option. Though your stakes are not of great value right now, but with the rise of high frequency trading the price may change rather fast. Besides, if you plan to raise additional capital, having unrestricted shares is one of the most lucrative bargaining chips with the possible investors.
3. Avoid having too many people overly involved
Having too many people involved means you’ll be spending your time on unproductive things instead of focusing on further development. If you are not careful enough, you may find yourself in an uncomfortable position, spending time on collecting signatures from your shareholders to make future financing decisions or implement new management decisions. Mainly, this happens when you’ve given these rights to your first investor and the follow-on investors happen to request them as well (see point 1).
Also, some investors prefer to receive daily/weekly/monthly detailed reports that will consume loads of your time as well. Clearly outline all of these points to your investors and settle on sending reports and having meetings only when it is truly necessary.
4. Avoid limits placed on management compensation
This is another recent trend of angel investing as some groups now insist on adding special clauses to financing agreement which limit top management salaries range. While such condition may look smart for businesses running out of funds or those in which the board of directors is too close with senior management, entrepreneurs should not hasten with accepting these terms. By having limits on salaries, you automatically cut down the amount of candidates you can possibly hire. One day, you may find yourself in the position when you need the best person to get the job done, but merely cannot afford them.
Instead, settle on creating a compensation committee for your new venture who will review salaries as part of a total budget.
5. Find investors who “get it”
Raising informal investment can be easier, however try not to involve people who have no experience or understatement in your niche. It may sound like a no-brainier, yet a lot of entrepreneurs prefer to go the easier way and invite everyone eager in financing afterwards spending hours on meetings explaining and persuading the early investors in just too many things.
The most productive cooperation occurs when both the investor and the team feel equally excited about the product. It will help you avoid all the financial twists mentioned above and let you raise more funds with less hassle involved.
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