Ask HN: First time investor - How do I not get screwed?

https://news.ycombinator.com/item?id=3237807

by brador • 15 years ago

7 13 15 years ago

news.ycombinator.com

Hi, I'm looking to invest $50k in a new startup at a 20% share. I have no experience in investing previously. It's a hands-off investment, and I'd like to avoid getting screwed on the deal when it comes time to exit/bring in new investment.

Any advice? What to look for in the deal? What to avoid? How to not get screwed out?

patio112• 15 years ago

The biggest piece of advice I have is to not invest any money in a startup if 100% loss of capital would meaningfully affect your life. (n.b. This is the same advice I would give would-be founders and early employees. If your kids can't afford juice boxes unless the startup succeeds, take the offer from AmaGooBook instead.)

Otherwise, pg has an article which better articulates pieces of advice I wanted to give like "start being a source of dumb money attached to someone you trust who did this before." See here: http://www.paulgraham.com/angelinvesting.html

brador3• 15 years ago

It's not money I need to eat, so not to worry there, but good catch.

Do you know if it's possible to have a clause that says something along the lines of "If you guys decide to up and quit I get your site and tech?"

patio112• 15 years ago

Yes, but I wouldn't really spend my time optimizing for the case where I end up with 100% of nothing if I were you.

lisper2• 15 years ago

> hands-off investment

> I'd like to avoid getting screwed

Those are two mutually-exclusive desires. If someone else is running the show and you aren't in the loop, then they will almost certainly be able to screw you if they choose to. At the very least, to avoid being screwed you'll need to be able to make a credible threat of suing them if they choose to screw you. The more hands-off you are the less credible that threat will be.

Investing is like any other job. There's no free lunch, no easy way out, and the more work you do the more likely you and the company are to succeed.

brador3• 15 years ago

Wouldn't a contract solve this? In terms of being able and willing to sue if they start taking liberties, I'm more than willing to do this, although knowing the two founder personalities I don't see this being that big an issue.

I note your point about being hand-off. It's something I didn't consider earlier. The question of "what if they decide to quit/change direction to one that sucks?" is something I missed and will consdier further.

The main issue I have is with me taking 20% of the current company, what are the methods I need to look out for that future investors can screw me down to 0% equity?

gyardley2• 15 years ago

Shares generally don't vaporize once issued, although you'll certainly experience dilution as new shares are issued unless you keep putting money in to preserve your stake. You'll also always be behind the new money in the preferences stack - newer investors get paid back first.

You shouldn't be angel investing, though - not if you'd actually consider suing founders because they might change the direction of their company to one you disagree with, or because they might decide to wind down the company should they fail and be unable to raise more capital. Both of those things are pretty normal, and the way angel investors deal with them isn't to come up with non-standard contractual terms, it's to have a portfolio of many angel investments, so their risk is distributed. If you're only going to be investing in one, you've just got to accept that you've got a very high chance of losing 100% of your investment. Founder malfeasance is the least of your worries - you'll lose it because most companies fail despite their founders' best efforts.

All you're going to do here is end up introducing non-standard terms into your investment paperwork which are going to scare away future investors and make the company you're investing in less likely to succeed.

lisper2• 15 years ago

Sorry for not responding sooner... I've been on the road.

First, they can't screw you down to 0%. Your shares are always your shares. You can be diluted down to epsilon, but not to zero. Also, the board has a legal fiduciary responsibility to act in the best interests of the shareholders, so there are limits to how capricious they can be. At the very least they have to be able to provide themselves with plausible deniability that what they are doing is in your interests.

There are two legal mechanisms for avoiding future dilution. One is to have a class of non-dilutable stock, but that is hardly ever done. It's a huge red flag for future investors. The other is to have a ride-along clause that gives you the option to participate in future rounds to maintain your current percentage share. It is rare NOT to have this clause, but the problem with that is, obviously, you have to be able to come up with the cash.

But by far your best option, since your stake is so high, is to take a board seat. Being on a board is all that time consuming, and it looks good on a resume too.

md1515• 15 years ago

Early stage startups are typically built to fail and although $50k isn't a lot in the modern sense of the word, you should really be careful in this situation.

You seem to be providing a small seed round so if they are successful, prepare to be diluted significantly (or forced to pay more to maintain equity portion). There are many rounds to come (Best case scenario).

The worst case scenario is that the money evaporates along with the startup. 20% of nothing is still nothing, unfortunately.

With regard to your acquisition of the site and technology - consult a lawyer. If the startup is incorporated already, then you will have to do some paperwork and you can ask for clauses that grant you I.P. rights if the company goes under.

A hands off approach would be nice, but you have to be careful. On the one hand meddling too much will interfere, but on the other hand doing nothing is typically a fast way to lose your money.

Best of luck if you decide to invest. If you have any other questions shoot me an email (in my profile)

AznHisoka• 15 years ago

I'm not an angel investor but got a couple of questions:

What stops founders from theoretically taking the money and run (shut down company, keep the money left)?

chris_dcosta• 15 years ago

Of course if you're talking 50K and a hands off investor, nothing.

But most larger investors might insist on baord appointments and a reputable CFO, and that's without the legal stuff.

Ask HN: First time investor - How do I not get screwed?

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