Most start-up entrepreneurs believe that successfully getting investor funding means the beginning of a great journey. What they don’t realize is that it’s also the beginning of a very different phase in their company; a phase some would even consider the beginning of hell.
When investors put money into your company, you lose absolute control of your company. That control now has to be shared with people who were not with you when you painstakingly founded your start-up, people who may care more about not missing out on an opportunity than your visions, missions and goals.
Investors are Opportunists
Let’s face it, one of the main reasons why investors put money into your start-up is so they can make money. And they will do anything to protect their investments, even if it means taking the company in a direction you might not like.
They’re not your friends or partners.
Though I’m not saying that all investors are bad, most are. The few good ones I know are what I call Entrepreneurial Investors. Entrepreneurial Investors are investors who were once entrepreneurs. They understand what it’s like to be a start-up and are usually more willing to help grow the start-up they invest in by sharing what they know.
Investors from Hell
When you get a bad investor, you could easily end up losing control of your company due to (all real life examples):
- Unfavorable terms
- Hostile management takeover
- Investors exerting minority rights after taking over too much equity
- Investors who don’t understand business and start imposing themselves
… and many more.
Though this isn’t what an investor-investee relationship should look like, it often is.
How to Avoid Investors From Hell
Most of these issues can be avoided if start-up entrepreneurs are aware and educated on what they must know before they take any investors’ money. This ranges from seeking the right investors, to valuation, term sheets, shareholders agreement and control.
In this article, I would like to share with you a checklist of eleven items you MUST look into if you want to avoid the pitfalls of taking investor money.
I would advise you to look through them carefully before you sign anything and before you take anyone’s money.
11 Things You Must Know Before Taking Investor Money
1. Are you raising money too little, too early?
If you are raising money too early, you may end up giving away too much equity for too little money. By doing so, you will face future hurdles in raising future funding rounds which you will end up being a minority owner in the future.
2. Are you ready to take in an investor?
It may be important for you to raise funds but is your start-up and your team ready to have investors on board when they start to scrutinize everything that you and your team does?
Is your start-up ready to implement corporate governance and transparency? Is your team ready to execute the business plan that you propose to your investors? Make sure you can execute with precision; otherwise, your investors will be breathing down your neck.
3. Do you know your potential investors well?
What portfolios have they invested in? Are the people whom you are going to work with approachable? Have you done your homework in finding more about them?
Were they entrepreneurs before? Or are they from the corporate side? Does your investors fit right into your corporate culture? Are they there to help you in your business and helping you to grow? Or are they just passive investors?
4. Is your company’s valuation realistic?
What stage are you in and on what basis are you making your valuation assumption? Is your business model proven? Or you are still validating your market? Can you justify your valuation model?
Many start-ups make their mistakes on asking too high valuation. The usual justification is that this is what they will get if it is Silicon Valley. Hello! We are not in Silicon Valley. Secondly, you don’t even have a proven model. How can you compare?
5. Do you have a compelling business model that will eventually help you to raise valuation and scale your business?
If you do, that means you are raising money to fund growth, which is the ideal stage of fund raising.
6. Do you do your monthly financial accounts?
Make sure you have your company accounts up to date. Investors often do due diligence on your accounts before investing.
7. Do you understand the terms of different investment instruments?
Investment instruments such as preferred shares, convertible note, redeemable convertible preference shares, and common stock are structured differently. Make sure you know what they means.
8. Do you have your own term sheets?
Term sheets are letter of intents between two parties – investor and investee who agree in principle to make an investment and take an investment with certain conditions.
Make sure you have your own term sheet drafted. You can produce it when the potential investors request for your term sheet. Try not to use the investor’s term sheet. Very likely it will work against you.
9. Do you understand the standard legal terms of an investment agreement?
You may want to have a lawyer vet through the agreement for you. If you cannot afford a lawyer, find a friend who is a lawyer (this means, you should befriend a lawyer). There are plenty of legal jargons that you may not be familiar of and could land you into serious trouble later on.
Some legal jargons such as “affirmative vote”, first right of refusal, tagged along clause, minority rights, reserved matters and a lot more could work against you in future rounds of funding or in your daily operations.
10. Are you ready to prepare monthly management reports once the investor money rolls in?
Are you ready for that? Is your accounting up to date? Make sure you are ready to produce management reports every month to your investors unless you want to be labeled a cheater and a liar. This also means that your financials must always be up-to-date.
11. Do you have a clear understanding about board seats and shareholders’ majority rights?
The control of a company is very key at the startup phase. Make sure you are in control all the time, which means, you have board majority and shareholders majority at all times. I overcame a hostile management takeover, thanks to my control of the board and shareholders.
Remember, investors are there to make money. They only care how much money they make and making sure that they don’t lose too much of their money. They don’t care about you. They just want a good deal. They are not your friends and partners. So you as the start-up entrepreneur, you must be aware. Seeking funding may be glamorous but take caution in unrealistic expectations.