A family member wants to invest $25k into our startup, what do we do now?

https://news.ycombinator.com/item?id=313809

by perezd • 18 years ago

34 48 18 years ago

news.ycombinator.com

We are a small 3 person startup, and have been working on a product designed for education. We presented a demo and the future concept to our family member who was interested in investing in our product and has agreed to invest $25,000 (USD).

Exciting! but, we aren't really sure where to go from here. I know that we need to speak to a lawyer at this point, but what kind? If anyone has a good recommendation for a lawyer in the bay area, forward me their info please.

Also, what about terms of the agreement? ie: equity agreements, shares, etc. Should these questions be answered by a lawyer?

The funding aspect of running a business is new to me and I want to make sure we aren't screwing anyone and that we are doing the right thing.

any pointers?

Thanks!

vaksel• 18 years ago

Think long and hard about doing this. There is a reason they tell you not to mix business with family.

perezd6• 18 years ago

Understandable, this is not a direct blood family transaction. They are actually a close friend of the family, and honestly the same fear should apply, of course.

They are in a position to provide us with a decent sum of angel funding, and they also are fully aware of the risk involved. Actually, they are quite excited about the risk.

run4yourlives5• 18 years ago

Actually, they are quite excited about the risk.

Everyone always is, because they're only focusing on the upside and not on the fact that once they give you $25K, it's already lost.

arockwell2• 18 years ago

Just in case you hadn't seen them before YC offers some boilerplate legal documents for angel funding that might help get you started. You can find them at: http://www.ycombinator.com/seriesaa.html

tptacek3• 18 years ago

CAREFUL.

See: http://www.law.uc.edu/CCL/33ActRls/rule501.html

In the WSGR Stock Purchase Agreement template you've linked to, the investor warrants that they are an "accredited investor", which long story short means they're a millionaire or have roughly a millionaire's typical annual income.

So far as I know, and having been involved in one minor legal spat involving accreditation (a former employer got bought by another private company, and a valuation negotiation pivoted on the fact that the new company couldn't simply issue me stock), you can't simply give someone 25k and "be an angel investor". There's more to it than that.

arockwell2• 18 years ago

Thanks for adding that. I really wish the YC documents came with some explanation or overview of what the terms mean. I really don't understand them very well.

Harkins• 18 years ago

http://www.andrew.cmu.edu/user/fd0n/articles.htm has a lot of nice articles on different ways folks can invest in private companies. Give them a read to understand the basics and then talk to a lawyer to write up the paperwork for the course you choose.

run4yourlives5• 18 years ago

Consider this: Say thanks, but no thanks.

1. You didn't ask for the money, it is falling into your lap. Therefore you don't need this money. Why not wait until you need it?

2. If what you build is great and is a success, that $25K will still be there, and you'll have a better idea of what to use it for.

3. If you fail miserably (You don't even have a product to sell yet), the loss of $25K will strain the family. Without it, this problem doesn't exist, and you move on, possibly with $25K to use for something else.

Promise them that they will be the first investor when you decide that you need capital, and get back to actually building your product.

perezd6• 18 years ago

we did actually ask to meet and present it with him. We are interested in the funding and will need it shortly or we will become under capitalized in the next few months.

We have been doing consulting work primarily to stay in business at this point, but we need to cut it off or else we can't dedicated enough time to our project.

in regard to #3, this relative is an investor by trade. He has invested 150K this year in oil and natural gas, he is completely aware of the risk and is embracing it.

I definitely understand the strain that could still put, but I am not his first family investment, either.

run4yourlives5• 18 years ago

Okay, that clarifies things a little.

I'm a big believer that if you need someone else's money just to get something off the ground, it doesn't mean enough to you. I think people are too quick to give away all their work.

You've got a consulting income, which you admit you could increase if you take focus off your project. Is it a bad thing to do this if it means you remain self funded?

How long does $25K buy you? 3-4 months? What could you do in 1 month? Could you release? Why/Why not?

The lack a money is a wonderfully powerful constraint in proving your idea. It's better to force you product to confront the realties of the market it is in (i.e., is it going to float or will it sink) as fast as possible. Taking capital can sometimes delude you into believing answers to this question that aren't necessarily the correct ones. It gives you an inflated sense of positivity.

Good luck to you, either way!

imasr2• 18 years ago

If he knows what he's doing and could help in more ways than just money, go for it. Else, pass on. Though, you should know that run4yourlives is right on this one. I've done it and couldn't regret more.

shimon• 18 years ago

run4yourlives raises some good points. But if you're sure you want to do the deal, the main thing you have to figure out is how much of the company your new investor will own, and how much of it will be owned by you and your partners. If you're not already incorporated you'll need to do that, and you can probably just include your investor as one of the founding shareholders (perhaps the only one who doesn't need stock vesting). If you are already incorporated, you can start with an angel financing doc from YC, and run it by a lawyer to make sure your case isn't special for some reason. If you're not sure where to find a lawyer, you should ask some startup founders you know personally -- this probably isn't a complicated scenario, but there's nothing like incompetent legal help to make a simple scenario into a gridlock.

DabAsteroid3• 18 years ago

Make sure they qualify as accredited investors.

http://www.google.com/search?q=accredited+investor+sec+famil...

If you later-on seek funding from VC's, and they find out that you have had any early investors who were not accredited, deals can fall through.

trickjarrett• 18 years ago

I can't offer any professional input, but I think you need a very strong warning about working with family. Make sure you lay out the expectations, their responsibility and power, etc. Having an investor adds many layers of trouble by itself, if that investor is family then deeper ties make it hard to interact professionally at times, etc.

Treat this 100% professionally from the start. Draw up contracts, stock reports, everything, anything you can.

prashantdesale• 18 years ago

I think you can take money by giving investor a convertible note.

Here is what I found on web regarding Convertible Notes.

------------------------------------- Convertible note is a debt instrument that can be converted into stock at the option of the holder or the issuer. More specifically, the investor can choose to convert the total amount of the note into equity when an institutional investor (such as a Venture Capitalist) makes an investment. ---------------------------------------

but off course you should talk to Lawyer before making decision.

fusionman2• 18 years ago

Convertible Debt is a popular instrument currently. Make sure you understand it though. What is it convertible to? This typically means that you intend to allow your debt holders to convert their investment to stock offered at the time of accepting Series A (or next round) funding....and they convert it at a discount....and the interest accrued is converted to stock at the same discount. Typically the max time frame for the debt is 1 year (securities issues I believe...has to be registered if longer), so if you don't anticipate taking additional funding in the near future, convertible debt is probably not for you. We could discuss this forever, but thats enough for now.

andhapp• 18 years ago

My suggestion would be to politely decline the offer. Never do business in the family it always leads to issues in the end and spoils the relationships. When money gets involved things go haywire....so beaware. They might show a lot of confidence and say things like "I do not care even if the money is lost" but this is not what they have in mind. No offences but unfortunately money takes precedence over anything else.

mkull• 18 years ago

I'm going to go against some of the other comments here say go for it.

The dicey part is how much equity they get, do they get paid dividends, do they only get anything back if you sell, etc. I am curious to see what others say as far as options and advice go in that respect.

My startup was in a similar situation (although it was a close friend who was investing, not a family member). Our situation was different, as they were expected to come on as a fulltime member of the team as well, but that never panned out (they couldn't put the time in due to other commitments).

So now it's dicey because the percentage given to them was based on $$$ investment + an expectation of day-to-day involvement (which never happened). So now its hard to quantify what their actual ownership is.

So I would advise to make it very cut and dry, and put it in ink (by a lawyer). An example of the chop-up (in layman's terms) could be they get say 7% of ownership for 25k with no other expectations from them other then a check. They get paid if you get sold / acquired or if someone buys their share otherwise they get nothing (no yearly dividends / bonus or profit sharing etc).

jon_dahl• 18 years ago

I say "Go for it" too. Find a lawyer before promising anything, even if it is a close friend who doesn't mind doing things informally. I don't know of startup attorneys in the Bay Area, but plenty of people here should. (If you don't get any responses, I'd directly email 5-6 YC startups in the area and ask who they use.) Your attorney will probably want to do a few things:

1. Button up your legal structure and organizational documents, if they need work.

2. Prepare a term sheet, subscription agreement, and other paperwork for the investor to sign.

3. Verify that the investor is an accredited investor (which I think means $1M net worth, or $200K salary for the last two years). You can take investment from non-accredited investors, but it is a lot messier, and may not be a good idea.

Money from family and friends is a time-honored way to bootstrap a business. You seem aware of the main risks (good chance of 100% loss, relationships can turn sour).

One more to consider is your independence. When you're working for yourself, you're only accountable to yourself. When you take on an investor, even a minority one, you need to think about your work through his or her eyes. If a better opportunity comes along in 6 weeks, you might not be able to jump on it because you now have a responsibility to your investor.

fusionman2• 18 years ago

@#3...$200k income for the past two years AND reasonable expectation this will continue.

jamiequint• 18 years ago

"I don't know of startup attorneys in the Bay Area, but plenty of people here should."

You don't necessarily need a 'startup attorney' or even one here in the Bay Area. If you're intending to raise a Series A in the next few months I'd try to get a relationship set up with a 'startup attorney' but otherwise you're just wasting your money. Go to somebody who knows corporate law, get an associate, and don't go with a big name firm. The stuff you want to do at this stage is likely very straightforward.

The best option for you at this point will be to do some sort of convertible note with a discount (of maybe 10-20% on your next round) or possibly a fixed cap (which is worse for you but better for the investor). This is good for two reasons; its simple, and it won't mess up your fundraising later on. You certainly should NOT give this investor control over anything (board seats, voting rights, etc.) the investment is far too small for any of that, and it WILL have an effect on your fundraising down the road.

I disagree with the previous commenter who says...

"If a better opportunity comes along in 6 weeks, you might not be able to jump on it because you now have a responsibility to your investor."

In reality the investor has no control over your actions, and also, if you find a better opportunity a good investor should be happy for you to jump on that idea. Assuming the idea really is better.

DabAsteroid3• 18 years ago

I'm going to go against some of the other comments here say go for it.

Whether or not to got for it was not the question. The question was how to proceed (lawyer recommendations, etc.)

babyshake• 18 years ago

Educational product? Do you have a demo/pitch? I'm generally very interested in educational software.

Of course, I'd be more than happy to tell you all about the education-related product I'm working on...

thelevybreaks@gmail.com

tptacek3• 18 years ago

I'd love for someone with more legal experience to start chiming in here about the legalities of accepting investment money from random friends and family. I concede that I don't really know what I'm talking about here --- that's why we pay lawyers --- but my understanding is that taking angel money is not as simple as getting the right purchase agreement in place. Not everyone is legally allowed to buy your stock.

Anyone else with actual experience or data on this? The YC boilerplate has a "must be an accredited investor" clause, and here's the SEC rule it references:

http://www.law.uc.edu/CCL/33ActRls/rule501.html

comatose_kid• 18 years ago

Just one thing to add - I know that you have already decided to take the money, but I know of people who were in the same situation. And they had two observations:

1) They took some money from a good friend and worked really hard to pay it back quickly. Their good friend thought that they were paying them back quickly to push them out of having a stake in the business (eg, she thought they were hiding large profits from her).

2) Every time they bought small things (eg, nice clothes for their kids), they wondered if their friend would think they were misusing the investment....

F&F investments can and do work well, but you have to be extra careful on how you navigate the personal minefields that may result.

fallentimes• 18 years ago

No.

Unless you absolutely, positively need it and as a last-resort-tried-everything-else option. I've seen too many of my friends & family ruin their closest relationships by having similar arrangements.

lsc• 18 years ago

I turned down money from my family... but I'd turn down money from anyone who wasn't going to provide me with more than just money. I want a business guy, with relevant contacts, and this family member was a business guy, but he didn't want to advise me on the business side of things.

SwellJoe• 18 years ago

Are they a high net worth individual?

If not, there are additional legal issues you have to contend with. Various "protect the little old ladies from being taken for a ride" laws make it more difficult for individuals who aren't worth millions to participate in private investing. At least, that's the case with corporations. With an LLC and proprietorship, I guess it's more like a personal loan and all of the legal stuff that surrounds personal loans would apply. Presumably you plan to, or already incorporated. As you've noted, spending a couple of hours with a lawyer is probably a wise investment. Just a phone call to a startup-focused lawyer will get you a few minutes of free advice on what you need a lawyer for (the better a lawyer is, the more likely they are to try to avoid doing extraneous work for you--they may charge twice as much, but they'll put in significantly less billable hours). Surprisingly, perhaps, raising bigger money from angels (who are high net worth individuals) can be less legally complicated, and the boiler-plate stuff that YC provides will probably do the trick.

joshu• 18 years ago

You need a corporate lawyer.

The family member has to be an "accredited" investor, which means they have at least a million dollars in liquid assets, not including home.

You might consider convertible debt here, so that you don't have to set a valuation now. Instead, it converts to stock possibly at some discount to and possibly at some valuation cap from whatever gets negotiated with a VC later. This makes life easier. The cap could be in the 500k - 3m range, depending on how much work you've got done.

I do get the impression that caps and discounts do annoy VCs, as well.

(Personally, I don't like doing converts -- I just want to place the bet. I've done ~ 7 angel investments, including one or two YC companies.)

Other people are wary about lending to family. I would tread very, very carefully here.

mattmaroon3• 18 years ago

As Steve Miller once said "go on take the money and run".

I'm assuming you think the money would help fund the business and is needed, or you wouldn't be asking. Maybe to help incorporate, host the project, etc. So why not take it?

You said in a comment that they're a professional investor. I'd find a decent attorney that will work on a deferred retainer and do a quick convertible (there's no reason to go equity here) and keep your fees to a minimum.

ninjaa• 18 years ago

since you don't have any legal structure and don't want to waste time and money finagling with lawyers etc, I suggest you borrow the money at a reasonable rate of interest (say 7-8%), and defer interest and repayment (set yourself a generous repayment schedule) beginning on a date, let's say 2 months after launch, for when it converts to equity or repayment begins.

This way you have cash in hand now, and details can be worked out as the product matures. If the house burns down you probably ending up owing maybe a $1000-2000 over the initial $25K, totally worth it for the freedom IMHO.

mjnaus• 18 years ago

Lawyer this, lawyer that... For every case that went wrong in the past, I am sure there is at least one that went well!

I was in the same situation as you are; what we did was quite simple actually. Together with your investors, agree upon a valuation for your concept (this is basically the hard part; don't try to come up with all kinds of revenue/profits predictions, just come up with a number both you and your investor can live with, dont't over-rationalize it) and give your investor equity for his money. Done!

I am sure many of you can come up with thousands of reasons on why a lawyer should be involved; however the simple approach worked fine for us.

I am going to go against everybody else here and say: "do it"! I would prefer having friends and/or family involved in my venture over some random smuck any day! There is a downside to everything, but come on! Making it sound like mixing f&f with business is a sure recipe for disaster is cow dung.

known• 18 years ago

What else can he contribute to your startup in addition to $25K?

A family member wants to invest $25k into our startup, what do we do now?

Related Stories