No matter what your idea is – be it to build a small start-up by bootstrapping or even a big one with tons of money from VCs– you definitely require some funding.
Though getting an investment is a triumph in itself, it is important to look at certain aspects while accepting it. When an outside investor gives you a big fat cheque, it may seem like the best possible thing ever. However, stop right there and check the fine-lines of what you have laid on the table for that money to come in. So every entrepreneur should know some fundamental realities of accepting the funding beforehand.
Let us take a look at 5 things that you need to consider while accepting an investment.
Type of Investment
The way an investor invests in your start-up has a drastic effect on your company. Actually, debt may be better than equity. Let me put it in a simple manner. If you are lent money by someone, what you have to do is just pay it back with interest. They do not have any say in how you run your company. However, if someone buys your stock, then they are your legal partner with rights.
Another point to consider is if you have an equity investor, he gets paid only if you are profitable. However, a debt security investor needs to be paid monthly even if your business is not yet profitable. So make sure you take an informed decision.
Type of Shares
If you have gone in for equity investment, then the next thing you need to look at is the type of shares that the investors are taking – preferred or common. Preferred shares have a higher claim on the assets and earnings than common shares. They normally have a dividend that must be paid out before the other dividends. So here the investor has more control over you and the company than the common shareholders.
If an investor is getting preferred shares it is not always undesirable. However, you need to understand the set of rules that come with it. You must be aware of the power you are giving them and plan accordingly.
Type of Investment Protection
Almost every investor (Equity) will ask for anti-dilution protection of their shares. When this comes up you should be pushing for what’s called a “partial ratchet.” Here the outside investors would get to buy additional shares at a price that is closer to the actual market price of the shares.
This is a win-win as they also get it at a lower rate and you do not lose as much as you would when it is a “full ratchet,” where you end up having to sell investors additional shares at the lowest price they were offered them at.
Type of Liquidation
When your company sells, how much money you make depends on the type of liquidation that you have planned for at the beginning. This is the order in which the business owners get paid if the business is sold or goes bankrupt. Depending on the preference you have signed with the outside investor, they will get a double or triple of their original investment. Make sure that you know what you have agreed to.
Types of Promises
Outside investors seek covenants or promises in the agreement as they are not always there to check on you. These can man anything and you must ensure that you are not promising anything that you can’t actually do. Ensure that you do not need permissions from investors before each and every decision or hiring that you do so that you can operate freely.
So be thorough on all the legal clauses before you take on an investor. There are chances that investors will seek certain things in their favour depending on the amount they are investing on your company and it may not always be a bad thing. What you need to do is be aware of what you are agreeing to so that you don’t get the bad end of the bargain in the end.