By Cliff Ennico
“I started a service business earlier this year. I formed a limited liability company (LLC), and I’m the sole owner.
Last week I met with an angel investor who is really excited about my idea. He has offered to put $250,000 into my company, some of which I could use to pay myself a small salary until the business can support itself.
There’s just one hitch (actually, two). This investor wants 49 percent of my company in exchange for his investment, and wants a seat on my board of directors (right now that’s just me). He also has an out-of-work ‘friend’ that he wants me to hire as an employee. While the investor is willing to fund his friend’s salary, he made it clear that he wants the friend to have some equity in my company if things work out.
I could really use this investor’s money, and with his extensive contacts with other local investors I really think he could help me grow the business. But I also feel he could be trying to take advantage of me, and I’m worried that I may end up working for him, his friend and his investor buddies down the road. What do you think?”
As the economy improves, I’m seeing more and more e-mails like this one. The good news is that angel investors are opening their wallets again after a long dry spell. The bad news is that some of them are getting a little greedy.
In a way, this investor is paying you a huge compliment, although it may not seem that way. He is willing to put a large sum at risk, he is willing to let you keep control of the company (at least for now), and he is willing to let you use some of his money to pay yourself during the startup period. As angel investments go, that ain’t bad.
You are right, however, to be worried that the investor could have an ulterior motive, and that this could be a “creeping takeover” in disguise. Since the angel investor probably doesn’t want to get his hands dirty running your business, you really want to focus on the investor’s friend. Does he do what you do? Will he be in a position to take over and run the company once you teach him the ropes?
If the angel investor insists you hire this person, and if you see him as a potential threat to your leadership, make sure he is an “at will” employee, meaning you can fire him at any time with or without a good reason. Make sure also you can fire the friend without getting the investor’s approval. As long as you have 51 percent of the voting equity in this company, that should be easy.
As for giving the friend equity in your company, it’s way too premature for that now. Your agreement with the employee should have a term of only one (1) year. At the end of the year, if the friend is really turning out to be a quality employee who recognizes you are the boss, you can discuss giving him options to acquire equity in your company going forward. The shares should be nonvoting (so you still have voting control of the company), and should be no more than 5 percent of the company vesting over three to five years.
Now, let’s talk about your investor and the 49 percent of your company he wants. Obviously, you should try to negotiate that down if you can, but don’t be surprised if he resists and says something like “look, I’m taking a flying leap of faith here on a totally unknown concept and an inexperienced entrepreneur so I deserve a big piece of the pie.” There may be some justification for that.
Assuming you like the answers, and are willing to take a chance with him, here are some things you should consider when structuring the relationship:
- Make sure that all management decisions can be made by 51 percent of the LLC owners if you and the investor don’t agree;
- Avoid “supermajority voting” provisions that would require you and the investor to agree before action could be taken on major decisions (especially the admission of new investors); and
- Make sure any additional capital he puts in is in the form of a loan to your LLC, not an equity investment (otherwise he could dilute you below 50 percent).
But your investor may reject all of these ideas. This is a classic example of the “Golden Rule” of business startups: he who has the gold, makes the rules. I don’t envy your situation. My best suggestion is that you pour yourself a stiff brandy tonight and ask two difficult questions:
- Is it better over the long run to have 51 percent of something, or 100 percent of nothing?
- Will having this investor on board make it more, or less, likely that your business will become a “something”?
Cliff Ennico (cennico@legalcareer.com) is a syndicated columnist, author and host of the PBS television series ‘Money Hunt’. This column is no substitute for legal, tax or financial advice, which can be furnished only by a qualified professional licensed in your state. To find out more about Cliff Ennico and other Creators Syndicate writers and cartoonists, visit our Web page at www.creators.com. COPYRIGHT 2015 CLIFFORD R. ENNICO. DISTRIBUTED BY CREATORS SYNDICATE, INC. @cliffennico.
