Fundraising · Early Stage Funding

What is the best way to structure an investment in my own startup?

Anonymous

March 9th, 2015

While we all have heard of investors bootstrapping, I'm wondering if there is an optimal way to contribute capital to your own startup as well.  Specifically, if there are two founders and my co-founder cannot match capital, what is the best way to structure a capital contribution in a way that will not give future investors heartburn?  Should that just result in additional equity for the contributing founder, and if so, based on what valuation?  Some friends have suggested debt, but I have heard of investors preventing repayment as part of the terms of their new capital.  Any insights?  Thank you! 
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Dan Kaminsky Executive Producer, Spice DNā, Digital Content Specialist, Video, Web & Social.

March 9th, 2015

We addressed this in our partnership agreement.  The value early partners brought to the start-up is key in determining how to manage this.  Bootstrapping in the early days may mean sweat equity.  As the business gets traction actual cash may be required, as in your case.  We predetermined a cash amount that partners would HAVE to match if the businesses truly needed it.  Beyond that one partner could infuse a greater amount of cash but would be first in line to get paid back in line with any profits.  If the amount of cash becomes considerably sizeable then a deal of some sort would have to be negotiated.  Any business should have clear provisions for investment whether by third party or existing partners.  If it's good for the business any good partner should be amenable to a fair deal.

Robert Tolmach Entrepreneur and Social Entrepreneur

March 9th, 2015

If a future investor insists on your founder equity vesting, then be sure that any equity arising from this funding is not subject to that provision. 

Derek Bereit Startup founder || python neophyte, NY attorney, veteran || general counsel Nimbo || co-founder Symptomly | Techstars

March 9th, 2015

Ray

(1) First issue is actually avoiding founder conflict (Dahrmesh Shah and Brad Feld have blog posts on this issue).  Slicing the Pie is brilliant application (as mentioned throughout chain).  Best option for starting or super early stage.  This mixes sweat equity and cash equity (and provides relative founder share value v. hard cash value). At this early stage, you should both be vested, as these are your agreed contributions. It is also valuable to put written restrictions on what money is used for (again, avoid founder conflict).  Cash equity (versus debt) shows "all-in" founder mentality most investors are looking for.

(2) re: Valuation. For going-concern, the only options are debt or equity (with complex mechanisms available to layer on top).  For equity, a reasonable valuation/benchmark is that of the last (recent) round--otherwise or just anticipate your next round--again important to make sure both founders are satisfied with valuation. (Debt runs risk of not being paid off by next round of investors (as you said)--but could still be converted at next rounds price.

(3)  The next concern (after valuation) is the treatment by subsequent investors.  The best way to handle is to create a new line item on cap table that shows your cash shares (versus founder stock).  This will be negotiated with investors re: vesting, treatment, etc -- but you open conversation by showing that cash investment is distinct.  Different (each?) investors will have different views--and several solutions at this point--again with debt which could be converted in new round. (BTW most likely outcome is you get vested, as they view founder cash as equivalent of sweat equity, depending on timing of investment)

(4) One other date point -- I was counsel to an acquired startup--one co-founder had founder stock (Year 0), subsequently issued options (Year 2-3), and cash purchased stock (Year 3-4).  The acquirer had no problem distinguishing between the different forms of ownership.

(5) For a fulsome discussion with empirical data -- see Chapter 6, "Founder's Dilemma", N. Wasserman.

(none of this post is legal advice!)

Kate Hiscox

March 9th, 2015

Hi Ray - use Slicing Pie to determine equity. Its a sound and fair model that determines and allocates equity for cash and non cash contributions. ᐧ

Anonymous

March 10th, 2015

Thanks very much, Derek! We need to connect again soon.

Anonymous

March 9th, 2015

That's my exact problem, Kate.  Most founder friends are suggesting I write it as a loan to the company in which I'll be simply repaid plus some small interest.  That would be ok with me, but again, I worry that seed investors (and then again later investors) won't want their investment going to what they see as cashing out a founder.  Equity is fine too, but the valuation gets interesting.  

I've been looking at the uncapped note that Matthew suggested, but I also don't want to be too unfair to myself if I'm contributing on day 1 vs when future investors come in with greater traction, etc. 

Annette Tonti Founder, President at The Start Exchange

March 11th, 2015

I suggest a convertible note.  I did this with my last company. It works well at this stage because it is extremely difficult to agree on valuation between you and your co-founder at this stage.  Even if you agree, your first angels, or institutional investors may not agree at all on your valuation (causing you to have to price lower which you want to avoid at all costs).   A debt note avoids the need to price your company now.

This way your money continues to gain interest, you get a discounted benefit with the conversion and certainly good terms if there is no next round.  Hope this helps.

Monica Borrell CEO and Founder at Cardsmith

March 9th, 2015

I 2nd the slicing pie suggestion.  it is so far working great for us! 

Tom Duffy

March 9th, 2015

that is a tough situation when one partner can put up money i would structure it as a buy in of their % of the business .

Matthew Himelstein I love to build teams and solve problems

March 9th, 2015

You might consider the convertible note route with no cap and no discount - but with a provision that states you get the note terms of the next round of financing (if they are better). That way you're not setting the cap or discount - your next set of investors are.