For any entrepreneur, finding the perfect investor is like a match made in Heaven. But as in any marriage, things don't always go smoothly. And if things get ugly, you can end up in court instead of living happily ever after.
To make sure that doesn't happen - and help startups avoid costly lawsuits (another instance where the only people who get rich are the lawyers) I asked Anton Rosandic, a California-based attorney and an entrepreneur himself, for some free advice. The solution isn't all that complicated, Rosandic says, "A successful investor/business owner relationship is all about managing expectations" and making sure all the terms are clear to everyone involved.
The first step is to pay attention to Rosandic's key do's and don'ts:
- Don't do a handshake deal; everything (and he means everything) needs to be in writing.
- Even if the investor is a friend or relative, don't assume you can skip the formalities. You can't. If something goes wrong, you want to make sure your relationship is "protected."
Just as important, don't play lawyer and try to write the agreement yourself. Instead...
- Get a lawyer - and make sure he or she is experienced in drafting investment agreements.
Then, before you sign any agreement, have the lawyers create a simplified description of the deal terms in plain English, so all parties understand the expectations, the deliverables and the consequences. For example:
- How much money is involved, and when can you expect to actually receive it?
- Is this an equity deal, and what percentage of the business does the investor get? Or is the investor loaning you money, which means you're taking on debt?
- If it this is a debt deal, what are the repayment terms?
- Is the loan secured by someone's house or similar collateral?
- When does the investor expect to see a return on their investment?
Next, clarify what say the investor has in the business operations. "For instance," says Rosandic, "will you have to get the investor's permission before making major decisions, like selling an asset or buying equipment?" Make sure your expectations match the investors'.
Of course, that's not all you need to worry about. Once you've covered the basic issues, Rosandic says there are still a lot of questions that need to be answered and clarifying that needs to be done.
- Clarify everyone's roles. Will the investor actively participate in the business as a manager or director? If so, what is expected of the investor as a participant? Will the investor be entitled to any salary or distribution?
- It's crucial to understand your investors' specific expectations for your startup. For example, are they looking for an increase in sales or in net revenue?
- Create a budget for the next 12 to 16 months so that everyone is clear on how you plan to spend the money you raise. "Even if it changes, and it very likely will, [a budget] gives you a starting point," explains Rosandic.
- What's your exit strategy? How do the investors expect to get a return on their investments, and are you onboard with that? Will you be selling the business, merging with another entity, or do you plan to go public?
- Do your investors have their own exit strategies? Can they sell their interest at any time? If so, do you have a right of first refusal to buy back their interest? Are there time constraints on a buyback? Do the investors have a right to force you to buy back their investments?
The sooner you know the answers to all these questions and the more everyone understands everyone else's expectations, the better you'll be able to manage not only your business, but your investor relationships.
Best-case scenario? "If your startup is successful," Rosandic notes, "most of these issues will be nonissues."