

A family member wants to invest $25k into our startup, what do we do now? - perezd

We are a small 3 person startup, and have been working on a product designed for education. We presented a demo and the future concept to our family member who was interested in investing in our product and has agreed to invest $25,000 (USD).<p>Exciting! but, we aren't really sure where to go from here. I know that we need to speak to a lawyer at this point, but what kind? If anyone has a good recommendation for a lawyer in the bay area, forward me their info please.<p>Also, what about terms of the agreement? ie: equity agreements, shares, etc. Should these questions be answered by a lawyer?<p>The funding aspect of running a business is new to me and I want to make sure we aren't screwing anyone and that we are doing the right thing.<p>any pointers?<p>Thanks!
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run4yourlives
Consider this: Say thanks, but no thanks.

1\. You didn't ask for the money, it is falling into your lap. Therefore you
don't need this money. Why not wait until you need it?

2\. If what you build is great and is a success, that $25K will still be
there, and you'll have a better idea of what to use it for.

3\. If you fail miserably (You don't even have a product to sell yet), the
loss of $25K will strain the family. Without it, this problem doesn't exist,
and you move on, possibly with $25K to use for something else.

Promise them that they will be the first investor when you decide that you
need capital, and get back to actually building your product.

~~~
perezd
we did actually ask to meet and present it with him. We are interested in the
funding and will need it shortly or we will become under capitalized in the
next few months.

We have been doing consulting work primarily to stay in business at this
point, but we need to cut it off or else we can't dedicated enough time to our
project.

in regard to #3, this relative is an investor by trade. He has invested 150K
this year in oil and natural gas, he is completely aware of the risk and is
embracing it.

I definitely understand the strain that could still put, but I am not his
first family investment, either.

~~~
run4yourlives
Okay, that clarifies things a little.

I'm a big believer that if you need someone else's money just to get something
off the ground, it doesn't mean enough to you. I think people are too quick to
give away all their work.

You've got a consulting income, which you admit you could increase if you take
focus off your project. Is it a bad thing to do this if it means you remain
self funded?

How long does $25K buy you? 3-4 months? What could you do in 1 month? Could
you release? Why/Why not?

The lack a money is a wonderfully powerful constraint in proving your idea.
It's better to force you product to confront the realties of the market it is
in (i.e., is it going to float or will it sink) as fast as possible. Taking
capital can sometimes delude you into believing answers to this question that
aren't necessarily the correct ones. It gives you an inflated sense of
positivity.

Good luck to you, either way!

~~~
perezd
we didn't start this business to be consultants, I hate consulting...I did it
for 6 years before we started our company, we want to build our product first
and foremost. we've spent the last year writing software for other people
(again), and I am tired of it.

~~~
run4yourlives
Okay, so after a year of development, my first question to you would be: where
is your product?

I've looked through your comments, and I suppose you will take this
investment. That's certainly your prerogative. I would say though that you
should put all that money into releasing whatever you have now in some way or
another. Kill whatever feature isn't done. Try to find an audience of
potential customers that will be willing to help develop your software to
finish. Some may even be willing to pay - you'd be surprised.

~~~
perezd
Actually, we've spent the last year as _consultants_, we haven't been able to
develop the product yet. We are starting that this month. Also, we are
approaching potential schools to sign up for the project up front as well,
giving them a deadline release date.

~~~
run4yourlives
Good luck to you. I hope things go well for you. If you didn't like consulting
though, just wait until you have to deal with school administration!

------
mkull
I'm going to go against some of the other comments here say go for it.

The dicey part is how much equity they get, do they get paid dividends, do
they only get anything back if you sell, etc. I am curious to see what others
say as far as options and advice go in that respect.

My startup was in a similar situation (although it was a close friend who was
investing, not a family member). Our situation was different, as they were
expected to come on as a fulltime member of the team as well, but that never
panned out (they couldn't put the time in due to other commitments).

So now it's dicey because the percentage given to them was based on $$$
investment + an expectation of day-to-day involvement (which never happened).
So now its hard to quantify what their actual ownership is.

So I would advise to make it very cut and dry, and put it in ink (by a
lawyer). An example of the chop-up (in layman's terms) could be they get say
7% of ownership for 25k with no other expectations from them other then a
check. They get paid if you get sold / acquired or if someone buys their share
otherwise they get nothing (no yearly dividends / bonus or profit sharing
etc).

~~~
jon_dahl
I say "Go for it" too. Find a lawyer before promising anything, even if it is
a close friend who doesn't mind doing things informally. I don't know of
startup attorneys in the Bay Area, but plenty of people here should. (If you
don't get any responses, I'd directly email 5-6 YC startups in the area and
ask who they use.) Your attorney will probably want to do a few things:

1\. Button up your legal structure and organizational documents, if they need
work.

2\. Prepare a term sheet, subscription agreement, and other paperwork for the
investor to sign.

3\. Verify that the investor is an accredited investor (which I think means
$1M net worth, or $200K salary for the last two years). You can take
investment from non-accredited investors, but it is a lot messier, and may not
be a good idea.

Money from family and friends is a time-honored way to bootstrap a business.
You seem aware of the main risks (good chance of 100% loss, relationships can
turn sour).

One more to consider is your independence. When you're working for yourself,
you're only accountable to yourself. When you take on an investor, even a
minority one, you need to think about your work through his or her eyes. If a
better opportunity comes along in 6 weeks, you might not be able to jump on it
because you now have a responsibility to your investor.

~~~
jamiequint
"I don't know of startup attorneys in the Bay Area, but plenty of people here
should."

You don't necessarily need a 'startup attorney' or even one here in the Bay
Area. If you're intending to raise a Series A in the next few months I'd try
to get a relationship set up with a 'startup attorney' but otherwise you're
just wasting your money. Go to somebody who knows corporate law, get an
associate, and don't go with a big name firm. The stuff you want to do at this
stage is likely very straightforward.

The best option for you at this point will be to do some sort of convertible
note with a discount (of maybe 10-20% on your next round) or possibly a fixed
cap (which is worse for you but better for the investor). This is good for two
reasons; its simple, and it won't mess up your fundraising later on. You
certainly should NOT give this investor control over anything (board seats,
voting rights, etc.) the investment is far too small for any of that, and it
WILL have an effect on your fundraising down the road.

I disagree with the previous commenter who says...

"If a better opportunity comes along in 6 weeks, you might not be able to jump
on it because you now have a responsibility to your investor."

In reality the investor has no control over your actions, and also, if you
find a better opportunity a good investor should be happy for you to jump on
that idea. Assuming the idea really is better.

------
arockwell
Just in case you hadn't seen them before YC offers some boilerplate legal
documents for angel funding that might help get you started. You can find them
at: <http://www.ycombinator.com/seriesaa.html>

~~~
tptacek
_CAREFUL._

See: <http://www.law.uc.edu/CCL/33ActRls/rule501.html>

In the WSGR Stock Purchase Agreement template you've linked to, the investor
warrants that they are an "accredited investor", which long story short means
they're a millionaire or have roughly a millionaire's typical annual income.

So far as I know, and having been involved in one minor legal spat involving
accreditation (a former employer got bought by another private company, and a
valuation negotiation pivoted on the fact that the new company couldn't simply
issue me stock), you can't simply give someone 25k and "be an angel investor".
There's more to it than that.

~~~
arockwell
Thanks for adding that. I really wish the YC documents came with some
explanation or overview of what the terms mean. I really don't understand them
very well.

~~~
tptacek
I think these docs are intended as a way to reduce your legal hassles, but are
misinterpreted as a way to eliminate lawyers. To take an investment, you need
a lawyer.

------
SwellJoe
Are they a high net worth individual?

If not, there are additional legal issues you have to contend with. Various
"protect the little old ladies from being taken for a ride" laws make it more
difficult for individuals who aren't worth millions to participate in private
investing. At least, that's the case with corporations. With an LLC and
proprietorship, I guess it's more like a personal loan and all of the legal
stuff that surrounds personal loans would apply. Presumably you plan to, or
already incorporated. As you've noted, spending a couple of hours with a
lawyer is probably a wise investment. Just a phone call to a startup-focused
lawyer will get you a few minutes of free advice on what you need a lawyer for
(the better a lawyer is, the more likely they are to try to avoid doing
extraneous work for you--they may charge twice as much, but they'll put in
significantly less billable hours). Surprisingly, perhaps, raising bigger
money from angels (who _are_ high net worth individuals) can be less legally
complicated, and the boiler-plate stuff that YC provides will probably do the
trick.

------
vaksel
Think long and hard about doing this. There is a reason they tell you not to
mix business with family.

~~~
perezd
Understandable, this is not a direct blood family transaction. They are
actually a close friend of the family, and honestly the same fear should
apply, of course.

They are in a position to provide us with a decent sum of angel funding, and
they also are fully aware of the risk involved. Actually, they are quite
excited about the risk.

~~~
run4yourlives
_Actually, they are quite excited about the risk._

Everyone always is, because they're only focusing on the upside and not on the
fact that once they give you $25K, it's already lost.

~~~
electromagnetic
It's a simple fact that most companies fail. Tell them to go to a roulette
table and bet on black if they want better odds.

~~~
perezd
Again, they are aware of the fact this is a high risk investment and are
prepared to call it a wash. They believe in what we are doing and that its
going to be a good product for education. Isn't that what investment is all
about?

~~~
electromagnetic
You seem more interested in convincing people that accepting the money is a
good idea. I'd say you're trying to do this because you know it's inherently a
bad idea.

I didn't spend three years studying psychology to learn nothing. You're
blatantly conflicted, if you thought it was a good idea you'd have taken the
money anyway. There's no reason you're on an anonymous news site asking advice
and when people make comments you're trying to back it up.

It's obvious they're aware it's a high-risk investment, I'm saying
statistically you've already failed. If you can't say without a doubt that
you're going to succeed then don't take their money because when you fail,
you'll need the friends.

I honestly hope you succeed, but my advice will be the same. Friends are worth
more than success or failure and money is too big an issue to have it in a
friendship.

~~~
perezd
you aren't getting it. we already PLAN to take the money, we want help with
HOW to move FORWARD.

I am not conflicted about the process whatsoever, I just wanted help figuring
out how to go forward with this investor.

------
joshu
You need a corporate lawyer.

The family member has to be an "accredited" investor, which means they have at
least a million dollars in liquid assets, not including home.

You might consider convertible debt here, so that you don't have to set a
valuation now. Instead, it converts to stock possibly at some discount to and
possibly at some valuation cap from whatever gets negotiated with a VC later.
This makes life easier. The cap could be in the 500k - 3m range, depending on
how much work you've got done.

I do get the impression that caps and discounts do annoy VCs, as well.

(Personally, I don't like doing converts -- I just want to place the bet. I've
done ~ 7 angel investments, including one or two YC companies.)

Other people are wary about lending to family. I would tread very, very
carefully here.

------
comatose_kid
Just one thing to add - I know that you have already decided to take the
money, but I know of people who were in the same situation. And they had two
observations:

1) They took some money from a good friend and worked _really_ hard to pay it
back quickly. Their good friend thought that they were paying them back
quickly to push them out of having a stake in the business (eg, she thought
they were hiding large profits from her).

2) Every time they bought small things (eg, nice clothes for their kids), they
wondered if their friend would think they were misusing the investment....

F&F investments can and do work well, but you have to be extra careful on how
you navigate the personal minefields that may result.

------
tptacek
I'd love for someone with more legal experience to start chiming in here about
the legalities of accepting investment money from random friends and family. I
concede that I don't really know what I'm talking about here --- that's why we
pay lawyers --- but my understanding is that taking angel money _is not_ as
simple as getting the right purchase agreement in place. Not everyone is
legally allowed to buy your stock.

Anyone else with actual experience or data on this? The YC boilerplate has a
"must be an accredited investor" clause, and here's the SEC rule it
references:

<http://www.law.uc.edu/CCL/33ActRls/rule501.html>

------
prashantdesale
I think you can take money by giving investor a convertible note.

Here is what I found on web regarding Convertible Notes.

\------------------------------------- Convertible note is a debt instrument
that can be converted into stock at the option of the holder or the issuer.
More specifically, the investor can choose to convert the total amount of the
note into equity when an institutional investor (such as a Venture Capitalist)
makes an investment. \---------------------------------------

but off course you should talk to Lawyer before making decision.

~~~
fusionman
Convertible Debt is a popular instrument currently. Make sure you understand
it though. What is it convertible to? This typically means that you intend to
allow your debt holders to convert their investment to stock offered at the
time of accepting Series A (or next round) funding....and they convert it at a
discount....and the interest accrued is converted to stock at the same
discount. Typically the max time frame for the debt is 1 year (securities
issues I believe...has to be registered if longer), so if you don't anticipate
taking additional funding in the near future, convertible debt is probably not
for you. We could discuss this forever, but thats enough for now.

------
mattmaroon
As Steve Miller once said "go on take the money and run".

I'm assuming you think the money would help fund the business and is needed,
or you wouldn't be asking. Maybe to help incorporate, host the project, etc.
So why not take it?

You said in a comment that they're a professional investor. I'd find a decent
attorney that will work on a deferred retainer and do a quick convertible
(there's no reason to go equity here) and keep your fees to a minimum.

------
trickjarrett
I can't offer any professional input, but I think you need a very strong
warning about working with family. Make sure you lay out the expectations,
their responsibility and power, etc. Having an investor adds many layers of
trouble by itself, if that investor is family then deeper ties make it hard to
interact professionally at times, etc.

Treat this 100% professionally from the start. Draw up contracts, stock
reports, everything, anything you can.

------
mjnaus
Lawyer this, lawyer that... For every case that went wrong in the past, I am
sure there is at least one that went well!

I was in the same situation as you are; what we did was quite simple actually.
Together with your investors, agree upon a valuation for your concept (this is
basically the hard part; don't try to come up with all kinds of
revenue/profits predictions, just come up with a number both you and your
investor can live with, dont't over-rationalize it) and give your investor
equity for his money. Done!

I am sure many of you can come up with thousands of reasons on why a lawyer
should be involved; however the simple approach worked fine for us.

I am going to go against everybody else here and say: "do it"! I would prefer
having friends and/or family involved in my venture over some random smuck any
day! There is a downside to everything, but come on! Making it sound like
mixing f&f with business is a sure recipe for disaster is cow dung.

------
Harkins
<http://www.andrew.cmu.edu/user/fd0n/articles.htm> has a lot of nice articles
on different ways folks can invest in private companies. Give them a read to
understand the basics and then talk to a lawyer to write up the paperwork for
the course you choose.

------
andhapp
My suggestion would be to politely decline the offer. Never do business in the
family it always leads to issues in the end and spoils the relationships. When
money gets involved things go haywire....so beaware. They might show a lot of
confidence and say things like "I do not care even if the money is lost" but
this is not what they have in mind. No offences but unfortunately money takes
precedence over anything else.

------
lsc
I turned down money from my family... but I'd turn down money from anyone who
wasn't going to provide me with more than just money. I want a business guy,
with relevant contacts, and this family member was a business guy, but he
didn't want to advise me on the business side of things.

------
babyshake
Educational product? Do you have a demo/pitch? I'm generally very interested
in educational software.

Of course, I'd be more than happy to tell you all about the education-related
product I'm working on...

thelevybreaks@gmail.com

------
ninjaa
since you don't have any legal structure and don't want to waste time and
money finagling with lawyers etc, I suggest you borrow the money at a
reasonable rate of interest (say 7-8%), and defer interest and repayment (set
yourself a generous repayment schedule) beginning on a date, let's say 2
months after launch, for when it converts to equity or repayment begins.

This way you have cash in hand now, and details can be worked out as the
product matures. If the house burns down you probably ending up owing maybe a
$1000-2000 over the initial $25K, totally worth it for the freedom IMHO.

------
fallentimes
No.

Unless you absolutely, positively need it and as a last-resort-tried-
everything-else option. I've seen too many of my friends & family ruin their
closest relationships by having similar arrangements.

------
known
What else can he contribute to your startup in addition to $25K?

------
DabAsteroid
Make sure they qualify as accredited investors.

[http://www.google.com/search?q=accredited+investor+sec+famil...](http://www.google.com/search?q=accredited+investor+sec+family)

If you later-on seek funding from VC's, and they find out that you have had
_any_ early investors who were not accredited, deals can fall through.

