Strings Attached: Assessing Outside Investor Deal Terms

Many entrepreneurs dream of the day when others see the value they have built in their startup businesses and potential for more growth, and are willing to write that big check – the one that provides enough cash to take their companies to the next level.

But is the dream all it’s cracked up to be? Just as there’s no free lunch, an investment from outside investors comes with strings attached. Some are strings you can live with and some are deal-breakers:

  • Loss of control over the company – The investor(s) may require veto power over any significant action to be taken, and in some cases, can acquire enough control to oust the founder(s).
  • Loss of return on investment – The investor(s) may require the founder(s) to be “locked up” and prevented from selling any portion of their ownership until everyone else has had the opportunity to sell first.
  • Paying all the financing costs – It is not uncommon for the company to foot the bill for all of the financing costs, such as legal, accounting, commissions, etc.
  • Paying ongoing costs – Often, investor(s) require seats on the governing body of the organization and also require D&O liability insurance, as well as annual audits, legal reviews, regularly held meetings (for which the attendees receive fees), and periodic reporting to investors.
  • Rights of first refusal and anti-dilution rights – The investor(s) usually reserve a right of first refusal to provide any additional financing a company may need. Even if any subsequent financing is not provided by the investor(s), they often reserve a right to participate in subsequent issuances of equity securities so that their ownership position will not be diluted.

Developing a response to these types of deal terms requires a great deal of assessment and contemplation. Entrepreneurs should take the time to review the goals they have set, establish or revise existing ones, and determine what they truly want from the businesses they have founded. Priorities change as life happens. Relinquishing control might have been a deal-breaker in an entrepreneur’s prime, but more appealing as retirement nears.

Contact Doida Law Group today if you are at a point where you’re considering selling your business and see how we can assist you with the process, mitigate risk, and help negotiate terms you’re satisfied with after exit. Click here to meet Fay.

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