

Ask HN: Percentage of gross income instead of normal equity share for F&F round? - ilaksh

I am trying to bootstrap an online business (been working on this some months).  I would prefer not to take any kind of investment at all.  I am even thinking of moving to the least expensive place I can in order to continue working on it.<p>What I was initially thinking of doing was borrowing a little bit of money from my family.  It would be borrowing a few hundred here or there to get by month-to-month.  The problem is that if I borrow even a few hundred in that context and it allows me to succeed, it might not be entirely fair if I don&#x27;t somehow distribute the rewards.<p>So then I started thinking about making a very simple spreadsheet for equity share.  There are some serious problems here for me though.  First one is, this is supposed to be a bootstrapped effort, not a huge venture-backed risk that is aiming to sell for millions of dollars.  I don&#x27;t know exactly what the equity would mean or when it would be distributed back to family who helped me.  I also think that whole valuation idea is questionable actually.<p>So my idea is this: I will make a spreadsheet distributing some percentage of all money coming in.  Maybe 10%.  Anyone who invests gets their portion of that gross fee pie sent to them at least every month.<p>So if I have 300 people sign up and their monthly fees total $5000, any family who helped me would be splitting $250 or $500 each month with percentages of that dependent upon how much they gave me.  They would not however have the right to direct the actions of my business in any way.<p>If I can get by without needing more money, then I don&#x27;t take anymore.  If I have to then I do, and that dilutes the original 5% or 10% of gross fees&#x2F;income.  (These rules are explained ahead of time of course to anyone who helps me).<p>The advantage of this: I know exactly how much its going to cost me, people know how much they can gain and it reduces their risk.  I retain control.<p>Any comments or advice about these ideas?  Thanks so much.
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patio11
Additional time spent on this problem does not make your startup more likely
to succeed. If you borrow a trivial sum of money from family, repay them,
optionally with interest. The end. (In the McKenzie family, at least, saying
the word "interest" causes a heck of a lot more strife than 5% APRs are worth
for either side of the conversation. This may be true in your family as well,
in which case just pay them the principal and be done with it.)

They can use the money to buy CDs with interest distributed monthly if they
wish to, which offloads lots of tedious grunt work to banks that have systems
and processes in place to deal with it.

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dctoedt
Some years back I played around with an idea like this as a possible funding
vehicle for smaller clients.

A few thoughts, on the assumption that you're in the U.S.:

1\. What you're talking about is somewhat like a royalty arrangement. The IP-
licensing world has a lot of accumulated wisdom about how, and how not, to do
those.

For example, your participants likely would want audit rights, or
alternatively for you to commit to providing audited financial statements
(which can be expensive).

2\. What you're talking about is also much like some types of preferred-stock
dividend, which are familiar to the financial community.

3\. Watch out for the securities laws. Depending on what the terms were, your
arrangement would very likely constitute a "security" under U.S. law. That in
turn would mean that (depending on who participated) you'd have to comply with
disclosure- and registration-or-exemption requirements under federal and state
law, or be subject to significant legal penalties.

4\. Also watch out for usury laws -- you'll want to structure your investment
so that it doesn't constitute a loan. (Although that's less of a concern,
given that _you 'd_ be the one paying "interest.")

5\. It could be dangerous to pre-commit to _paying out_ X% of your gross
revenue each month. That could create a severe cash-flow crunch and constrain
your ability to grow the business. Don't forget that you _must_ pay taxes and
remit tax withholding for any employees you have (or the IRS will come for
your house), and you really want to make payroll if you want to keep your
employees around.

Instead you could consider having unpaid royalties accumulate. (That's like a
cumulating preferred dividend.)

6\. You'd want the right to buy out your participants (sometimes known as a
"call") and would need some sort of formula to determine the buy-out price.
Without a buy-out option, it might be difficult to attract other investment
and/or to be acquired.

One approach I've toyed with but haven't thought through: The buy-out price is
some multiple of the amount the participant paid in, increasing at Y% per year
but reduced by the amounts of any royalty payments. That'd be like a bathtub
with both the faucet and the drain open: The water level rises and/or falls
depending on the comparative rates of flow in and out, with the "water level"
at any given time being the buy-out price.

7\. You definitely want to check with a lawyer about this (not me; I don't do
this kind of work). As usual, don't rely on this as a substitute for legal
advice about your specific circumstances; YMMV; etc. etc.

~~~
alain94040
You are overthinking this. The post describes loans from family members for
about $100 each. I'll support what Patrick said: just make them simple loans,
probably not even with interest.

The only other approach I can think of, if the amounts get slightly bigger and
the owner really wants to give the family a "share" of the action in case this
really takes off, is to issue convertible notes. They are very easy to do in
volume. They are effectively loans, but with a conversion clause into equity
that can be applied if the company actually takes off.

~~~
dctoedt
> _You are overthinking this. The post describes loans from family members for
> about $100 each._

What he (?) says _now_ is that it's just family members. If it works --- or if
he needs more capital than he can raise from just family --- he's likely to
want to expand its use. That can lead to major legal trouble. Moreover, others
might read his idea and want to do something similar.

