Things To Watch Out For When Accepting Outside Investment – Part 1
Accepting a big financial investment from an investor or venture capital might sound like the ideal scenario for a startup founder. However, the details of your contract determine if this investment is going to help you or not.
This article will introduce the most critical contract items to watch out for when negotiating an agreement to accept outside investment.
I often hear that angel investors are known to use any excuse to get in their equity, and therefore, these investors need to be kept away from the company. What I tell people who worry about this is that, as a founder, I have made a lot of investments in startups and have come across angel investors who were right for the investment and others who were not. Not all angels are bad, and in the vast majority of cases, the angel is a passionate investor that understands the value of your business. When negotiating a specific agreement, there are several things to pay attention to so that you don’t end up making a bad investment.
What are the things to watch out for when accepting outside investment?
Certain interest charges might be imposed on the startup founders. When the startup has invested $10 million, investors will charge startup founders (current and future) an additional 10% interest on their investments, up to a limit of $25 million. This means if you make a $5 million investment, you will charge interest of $1 million. This additional 10% interest is known as “acquiring interest.”
Care and feeding
When you accept outside investment from a VC or an investor, they will expect your company to grow. But that growth can cost you quite a bit of money. At the beginning of the investment period, the new investors will typically provide capital for “care and feeding” expenses for the startup.
How much equity should you give up?
An investor will want to see that your company is financially healthy. Therefore, they will want to get a financial commitment to the amount of equity that they are going to purchase from you. Based on your company’s balance sheet, you should be able to demonstrate your potential profitability and provide a solid financial position.
How will the money be paid?
Regardless of your success, investors want to ensure that you have the ability to service or repurchase their investment. This is especially true for venture-capital financing, in which companies are often unable to repay the debt. What if you lose the business? If you are unable to repay a debt, an investor will likely hold back their investment and wait for a new round of financing or liquidity before continuing.
What rights do you retain?
An investor is supposed to support your business by making investments and offering their expertise to help you grow your business. The terms of an agreement should also state the rights of each party after the investment is completed. The following detail help you understand how to protect your company.
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