Home » Investing in Startups: How to Protect Founder’s Interests?
The format of investing in a startup is most often chosen by the investor, trying to protect his interests as much as possible when financing a start-up. This happens because many novice businessmen believe that the very fact of attracting additional funds to the project puts them in a more vulnerable position and implies agreement to all the conditions of the investor. However, not only the investor’s interests can be violated during the promotion of startups.
Businessmen also need to assess the risks that can lead to the most undesirable consequences. Frequently, if the business succeeds, the investor appropriates the entire project and the profits, and if the project fails, the startup founders still have to return the money spent on their business. In this article, we will tell you about the ways of investing in a startup and getting the best for real money, considering all the risks for all sides of the project.
The Four Most Common Ways to Invest in a Startup
Business protection is based on two main points:
Choosing the legal status of the company, which will ensure maximum protection of the interests of all project participants;
Registration of borrowed funds, which will fully reflect all the conditions for their return.
We consider the creation of a limited liability company to be the most preferable way to legalize a startup. Creating a joint-stock company at the stage of starting a business brings a lot of difficulties, and it is much more profitable to invest more effort in the project itself than in extra-legal issues. As for the formalization of relations with an investor, it is much more difficult to maintain a balance of interests. The four most common ways to invest in a startup are the following:
Inclusion of an investor in the structure of the company
This method is the most common in the practice of attracting investments. And, perhaps, it really serves as protection for both the investor and the founders of the startup. Moreover, it is very important to correctly distribute the roles in the business and allocate an appropriate share to the investor. More often, the investor is provided with a small share of the company (usually 10-30%). The rest of the funds are invested directly in the business – the purchase of the property, equipment, hiring contractors, etc. Thus, the investor can control how his assets are spent, and the founder of the business does not lose a significant share in the distribution of profits.
Registration of an investment agreement
An investment agreement is concluded if the investor does not plan to take any part in the life of the company being created. In this case, he does not become a member of the company but receives the profit prescribed by the contract upon the occurrence of certain conditions.
This is a relatively new way of formalizing external business financing. We consider this method beneficial for all business participants. If the project is successful, the investor can either ask to convert the loan into a certain share of the business or demand the return of the money invested with the dividends due to him. However, you should pay attention to the conditions for the return of borrowed funds. Very often, investors force concluding an agreement on such terms that if the business does not bring the proper profit, then its founders must still return the money spent.
Simple loan agreement
This method is often used in the practice of making investments, although we do not believe that it can fully protect the interests of all participants in investment activities. The risk of losing business is minimal because the investor does not acquire a share in the company. But this method is extremely unprofitable for novice businessmen, because if a startup fails, then the money will still have to be returned.
How to Maintain Influence in the Project?
Properly drafted charter and corporate agreement is the key to the success of a startup. Try to think carefully about the mechanisms of action in case of various conflicts and contentious situations. Many conflicts can be avoided if the constituent documents are sufficiently thought out.
If you intend to involve many investors at different stages, then it is very important to correctly determine the ownership structure of the business. This will avoid a situation when the share of the startup founder is gradually eroded due to the attraction of new investors and the cumulative increase of their shares in the company.
Many investors, especially if they are actively involved in the project, will impose their vision of the correct business conduct, and someone may even hire their own manager. Therefore, your place in the company directly depends on how you build a control system for all processes in the company.