equity, investmentSo I want to start an IT company - in an established domain (Wordpress themes/plugins) and need capital for it to establish and grow until it becomes profitable. While I do this, I’ll also need to pay myself regular salary while I work on it. The money that I’m looking for will keep the company afloat for about a year, hopefully by then it will already become profitable.
When I reached a group of potential investors (3) (friends of friend) they are proposing me that: we all invest equal amount of money and we share equal equity of 25% (including myself). Since I do not have money to invest myself right now, they are okay with me investing my share later on.
This seems fair in a way that - we all are going to invest equal amount of money and get equal share - plus I will also get salary for running the company.
However part of me says that - since I’ll be running the company from inception to growing it to what it can become, and as the only solo founder working on it full time and invest years building it - while they are mostly only going to invest and help with only occasional involvements while keeping their full-time job - I should be getting majority of the ownership vs them as an investor getting <50% in total.
While the situation is - without the money I won’t be able to run the company and it’s not too easy to get funding. Also at this point the company is nothing but an idea and proposal.
Help me analyse the options please.
You seem to understand the problem pretty well. I have been in nearly an identical situation. And although it ended quite successfully, there was enormous heartache, frustration and infighting along the way.
Let me mention some things you will discover if you go that route :
1) If they already know each other then they will coordinate with each other privately about every issue before talking with you, to assure that every decision goes their way.
2) They will insist on using an attorney and accountant who they already trust. See point 1) above.
3) If you need money unexpectedly for the company, that will be your problem to solve. But they will have veto power over most solutions because pretty much all financing documents will require all principles to sign, at least until the company is very solidly established. If vetoing your solution puts you in a bind, that will be your problem to solve, since you will be the point person running the company.
4) All other prospective partnership doors will slam shut. Whatever arrangement you make with them will likely be something you will have to live with for a long time.
5) They may ask you to sign an employment contract which could make you financially liable if you decide to walk away, even if you are mistreated. It is critical that you understand that things will not always be harmonious, and that is when people pull out signed documents to see what leverage they hold over you. My recommendation is that you take the position that you are an equal partner and signing an employment contract (or any pseudonym) would misrepresent that relationship, and you are not willing to do it.
6) They will act as though documents are written in stone and cannot be edited. My recommendation is that any time you are presented with a document to sign that your natural response be “Sure, I’ll have my lawyer look it over”. And if you see something scary in it, calmly and politely suggest language that makes you feel more comfortable and is fair to all parties. If they become belligerent over reasonable changes then walk away. That is a red flag, and a sign of years of future infighting to come.
Every situation is different, so I can’t say what the right decision is for you. However, I can tell you that my current project is much larger than my first, and I have chosen to work part-time to fund it, and engineer it completely on my own. I am buried with tasks all of the time, and I sometimes worry that I may not finish. But I sleep a lot better. A pot of gold that everyone has pissed in is not as satisfying as you may imagine.
As they are essentially equity investors (not working on the product/service themselves) rather than founders then you would leave yourself in a position of being near un-invest-able in the future.
Any future investors would look at your cap table and realise that the sole founder (you) only held 25% stake of their own company and that 75% of the equity was held by individuals with zero day to day involvement in the business - so 75% of the equity is not working towards the day to day success of the business and as such is wasted.
Also any future investment would dilute the founder further into the position of having very little up side on exit or any motivation beyond the coolness of the project and the salary they are bringing in. This is not a long term investment or the founder could simply be replaced by staff on lower wages.
Seed round investment, in my opinion, should leave the founding team with more than 90% of the equity available in order to give them somewhere to grow and give the appearance of being able to take investment (unless the investment had many zeros).
Even if you are not looking for future investment the appearance of being able to accept investment automatically pushes potential acquisition offers higher as a buyer knows that you can reject their bid, take investment and increase your value further without having to sell.
My advice to you would be to maintain control of your business. I would do so by introducing your investors to the SAFE agreement (https://www.ycombinator.com/documents/). This stops you from having to value your company initially (which is impossible) and puts checks and balances in place to look after your investors when you grow. As in, they get a better deal (discount and/or preferences) on the equity next round when a more experienced investor comes on board and can negotiate more fairly on their behalf. It will also reduce the need for lawyers early on as the documents are straight forward.
I would also look at putting in place an agreement between yourselves and your investors in which you have a board of directors (these do not have to be shareholders). Essentially the board makes decisions about the business rather than the shareholders although shareholders (as a group) can reserve the right to place a member on the board - they would usually reserve this right until the sh*t hits the fan and they are saving their investment rather than up front. This means that you are not outnumbered by shareholders who have no day to day involvement or perhaps understanding of any aspect of the business. You can make decisons, give updates and reports to your shareholders and be held accountable by the board of directors. Each month you send out a share holder report updating them on your progress, any actions you agreed to take etc. The report early (when the board is essentially you) on will be lightweight and update on key metrics. As you get a larger board or chairperson these reports can be more formalised with meeting agendas and such.
The key thing here is to get the strategy right ahead of your idea. understand that investment does not give them control of the business, it should give them influence and that you must look after your own equity stake because investors like an incentivised founding team.
Good luck, it sounds like a difficult position to negotiate from
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