The great day has arrived. Tomorrow, you're going to close your first professional investment with "Fred," a wealthy individual you met at a networking event. Just this morning, he called to tell you how enthused he was.
"Just a couple of tweaks from those lawyers," he laughs with a wink in his voice. "They're making me put in some technical stuff. Nothing to worry about."
When the list arrives, you decipher the changes and seem to find that his investment is now a loan and requires preapproval from him to borrow more, along with a new set of warrants based on performance. It looks like if you miss your quarterly goals, Fred will own more and more of your company. He's also requiring that you source your software development through his consulting company at a price "to be negotiated." Finally, if you fail to agree on a price for the development within 6 months, he gets his money back with 18% interest.
This wasn't the deal you thought you were getting, and in the meantime, you've turned away several other investors. It's true, you did talk to Fred about his development capability but you hadn't really expected this.
And, while you haven't really spent the money, you have certainly got plans. If you accept this deal, you really can't prudently spend anything for six months while you negotiate a price.
"Well," you think, "we can work this out. I like this guy."
1. Did you get references from people he's done deals with? From references that you got from the references he introduced you to? Have you checked him out on the jungle grapevine?
2. Have you asked him - directly, if politely - what the meaning of these changes are? If you start using lawyers to talk to each other, each will do what he is paid to do - represent your position and work back and forth, hopefully towards agreement - and as a byproduct, a big bill.
Does this happen? Is the sky blue?
- A business fall into the hands of a minority investor who controlled the offshore manufacturing.
- Deals that were put together so poorly that the entrepreneur had little room to work.
- Structures that disproportionately favored one side over the other.
Good deals do none of these things. Good investors never let their advisors make substantive document changes without discussing them with you. Good deals are easy to understand and don't motivate one party or the other to work against their mutual best interests.
In all of these cases, the investors were individuals working with the entrepreneur directly. This is great if you know the person investing or you know their reputation.
But, if neither of these facts apply, be very cautious. Groups of investors usually cannot afford to try this kind of stuff; their deal flow dries up.
After all, the investor is thinking of you, the entrepreneur, from a cautious perspective. Do the same.
Or, "Err in Haste; Repent at Leisure."