Investors can be exactly what your business needs. But with them comes a world of complications and sometimes terrible problems. Their goals are not exactly aligned with yours, and so investors gamble with your business. Here are some ways to protect yourself.
Previously published in Starting from Zero.
Investors Don't Have Your Goals
You think you're both after the same thing, to make the company a success. But you're not. You want to build a successful company that you can either keep long term, or sell off to a buyer. Your investors want to make a profit on the money they invested, the sooner the better. These are two very different goals. While you're thinking in terms of 5-10 year blocks of time, your investors are wondering after 6 months why you're not a huge success yet. By one year in, they're worried and they're thinking about how to get their money back, or get the company away from you.
7 Ways To Protect Your Business
- Don't give away more than 20% of your business
This is probably the most obvious and basic ways of protecting your business from investors. Shares are votes in running the company. So if you sell more than 50% of the shares, you're handing over control of the company to your investors. Likewise, think of what your future rounds of investing may be. If this is only your seed round, or Series A, you don't want to give up more than 20% – so that you can bring in a second and maybe even a third round and still keep 51% of the company yourself.
- Keep the majority of your board of directors newtral
Boards should be small to begin with. Three members is plenty for an early-stage startup. One will be the board seat that the investors get. One is yours, and one is a third board member, who should be neutral to the investment group. That way, you and the neutral board member can out-vote anything the investor-board-member proposes (in case he proposes something bad for the health of the company).
- Don't share the ups and downs of daily business
Some investors will become very involved in your business. They may actually want a job working with you or demand monthly, weekly and sometimes daily updates. (I had an investor – briefly – who sent me dozens of emails every day for 2 weeks until he suddenly pulled out and demanded his money back.) Don't agree to anything more frequent than quarterly reports. This is standard and ensures that investors are kept abreast of all the significant happenings, but don't interfere with the daily running of the company.
- Don't let investors control management compensation
Investor groups have started over-reaching in their demands, and one of these is controlling how much you can pay your top employees. This is dangerous, because they may shackle you to low salaries, ensuring you never attract the top talent.
- Don't agree to terms that require you to expose or explain every legal agreement your business has ever entered into, or guarantees that your business is compliant with all laws, licenses and regulations in every state.
Most of us are honest, law-abiding business women and men. So this isn't about hiding nefarious activities, but about reducing the busywork involved in taking on investors. AND closing up loopholes that unhappy investors could use years later to cause your business problems. (You forgot to show them the 2 week contractor work order for the freelance designer? You're in violation of their investor agreement and now you have to give them back $100k.)
- Don't give your investors to the right to vote on future investing rounds
This is a biggie. If you're going down the investor path to begin with, you're likely to have several rounds of investment. You don't want your first group to keep you from ever taking future investments. They'll think they're protecting their investment from dilution, but they're really starving the company and will kill it.
- Don't bring investors in as employees
Investors can only be two things: Silent or partners. You can't boss your investor, those two roles don't mix. So if you hire someone who has also invested in the company, know that they're your partner – no matter what title or job you give them.