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    3 Replies Latest reply on Mar 8, 2008 4:23 PM by LUCKIEST

    Factors to consider when getting external funding

    LondonLuke Newbie
      What factors should I be weary of when negotiating with external investors wanting to invest in my business?

      We are seeking first-round of external investment in order to expand our internet business. Like many business founders, I am weary of relinquishing shares and control to investors. I have heard a few horror stories recently about investors negatively impacting on businesses they have invested in. With that in mind, can you tell me what positive/negative experiences you have had with investors? More specifically, what areas should I look out for when negotiating investment?
        • Re: Factors to consider when getting external funding
          Lighthouse24 Ranger

          I'm not sure your questions could be answered completely in a hundred posts, but at the risk of providing an over-simplified and incomplete response, I'll try to at least get the discussion rolling . . .

          Since you wrote "first-round" funding (as opposed to seeking outside funding for the first time), I'm assuming that you already know there will a second round and that you're most likely looking at a convertible debt or bridge note deal for this one. Those agreements are usually fairly simple and straightforward -- (1) amount of financing, (2) interest rate and payment terms, (3) convertibility terms (including price and discount), (4) prepayment terms (5) terms for a liquidity event (like a sale or merger), (6) warrant coverage, and (7) subordination and security interest clauses. In general, you negotiate the terms, plug in the numbers, run a variety of scenarios, and determine if you're going to be happy or not.

          Aside from agreeing to the actual terms, the main "problem" with these deals is that first-round investors may have an "incentive" to want the valuation of the company in the second-round to be low (so they and the subsequent series of investors can increase their percentage of ownership in the company relative to the founders). Also, the initial investors may request unusual terms (for example, requiring the company to grant a security interest in all assets, provide personal guarantees from the founders, and agree to some fairly drastic measures in the event of default). So these would be some factors to look out for.

          It's counter-intuitive for an investor (especially "seed" and first-round investors) to negatively impact the business they're investing in. From what I've seen, "control" issues usually arise when there is disagreement about where the company is going and how it will get there. A lot of business owners don't understand that the decision to quickly grow a small start-up into a highly profitable business enterprise (to "put it on the map" so to speak, and to provide attractive exit strategies for investors along the way) is all about the original founder relinquishing control. If the founder doesn't want to give up some ownership and control, he/she should stay "small" -- small can be beautiful. If the goal is to have the next Google or something, the founder will need other people to help get it there.

          So -- maybe someone else can take the discussion from here . . .
          • Re: Factors to consider when getting external funding
            LUCKIEST Guide
            Welcome to this web site. Lighthouse 24 always gives great answers.
            You know your business BEST and have watched it grow and I understand being weary.
            You can get great support and advice from your family. Other executives in the company.
            Your Accountant and their firm, your Lawyer, your Banker.
            There is also a lot of info if you google Factors to consider when getting external funding
            Best of luck, LUCKIEST
            1 of 1 people found this helpful
              • Re: Factors to consider when getting external funding
                Lighthouse24 Ranger

                To expand on what Luckiest wrote, you might create a Board of Advisors. This board doesn't have to be a "formal" group that meets -- it's really just a list of people in your area who have knowledge, connections, or investment interests that you don't (having a seat on your "board" might be a prestige thing for some). The way it would actually work, however, is you'd simply take someone on the list out to lunch or for a round of golf or something in exchange for a chance to bounce some questions and ideas off of the person. (DomainDiva's posts in other threads would suggest that she has made great use of informal advisors to launch and expand her company. Maybe she'll add comments here.)

                Keep in mind that there are maybe 6 million small businesses in the U.S., and most of the founders of these businesses have never gone through a full series of outside investor funding -- and never will. Only a relatively small number have been through it more than once. In contrast, there are about a thousand angel groups and VC firms that negotiate deals like this every week -- so no matter how much we try to educate ourselves, they still have a bit of an advantage! Even the sharpest business owners (guys who get their pictures on the covers of business magazines) have agreed to bad terms at one time or another. It wasn't the end of the world, though -- they learned something and moved forward, and you'll probably do the same.
                1 of 1 people found this helpful