

Ask HN: Danger of raising money for a consumer web startup - WiseWeasel

I'm posting this under a pseudonym in order to protect the naive. I'm involved in a consumer web commerce/entertainment startup. We've spent a significant amount of time refining our prototype and we're just getting ready to start accepting content in anticipation of a public beta launch. We would ultimately expect to burn through a few million dollars to reach profitability, largely bandwidth, but we're bootstrapping as far as we can.<p>We've quite randomly encountered a team of would-be startup incubator / money finders / placeholder executives who after meeting somewhat briefly with us and looking over our (slightly informative) business plan and partially functioning demo site, suggested that we re-form as an S Corp in Delaware, which would be preferable to our current LLC in California. They then sent over an offer to pay them $7k (half up-front) for the preparation of an investment kit (incorporation, business plan, stock purchase agreement, etc.), and mentioned a 4% commission on money raised and 4-7% founders' share equity for them with a ~$3M series A open-ended round, and that we would be able to keep majority share for the founders at that valuation.<p>Now, given the fact that we would apparently be their first clients, this is the point where most sane people would run away screaming. We declined their generous offer for the investment kit preparation as too risky for us given their lack of track record, but they would like to meet for more in-depth discussion and possibly some other kind of arrangement.<p>It's probably unrealistic for us to think about a series A round before we have content licensed, let alone users and revenue. That said, what do you think about involving people like this in a startup? Are there any red lines that we shouldn't cross here, for fear of making us unattractive to investors? What are some ways of minimizing our risk as we seek partners in raising money? Are there any particular resources you might suggest for us?
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kerryfalk
I don't think the fact that you'd be their first client is why you should run
away screaming, I think all of what you said here is:

"They then sent over an offer to pay them $7k (half up-front) for the
preparation of an investment kit (incorporation, business plan, stock purchase
agreement, etc.), and mentioned a 4% commission on money raised and 4-7%
founders' share equity for them with a ~$3M series A open-ended round, and
that we would be able to keep majority share for the founders at that
valuation."

I don't know an investor that would be happy paying 4% management fees to a
middle man, or one who would want to work through a middle man instead of
directly with the team tasked with executing.

Perhaps I'm misunderstanding how you're presenting this. But if I am
understanding correctly this sounds like a very bad situation to get mixed up
in.

Don't walk away, run away.

~~~
WiseWeasel
It seems the 4% commission on the money they raise is the most controversial
aspect of this arrangement for those with experience in this area, which is
not what I had anticipated. I could certainly see how investors might be
troubled by that though. Thanks for the feedback!

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anonymouz
The following is not specific to startup funding (which I have no experience
with), but general advice when it comes to financial offers: Whenever someone
promises you a seemingly very large amount of money in exchange for a
comparatively small up front fee (paid by you), there is a very high chance
that something is fishy as this is a SOP for all kinds of fraud. If you still
want to go ahead, ask for the fee to be deduced from the payment you will
supposedly receive. If the offer is genuine this should not be a problem.

~~~
WiseWeasel
Yeah, the fee was what I focused on most in my decision to decline, as it just
seemed like I would be making it too easy for them to screw us.

Note to Hisoka: looks like you've been ninja banned.

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brudgers
There is nothing in the proposal that sounds like a good deal.

You pay cash (of which you are short) in exchange for some documents prepared
by someone with no track record who you "randomly encountered."

In particular, for a startup (of the type YC tries to create) an S-corp is a
lousy idea because they have only one class of stock and are precluded from
taking investment from many types of corporate entities.

On the scam side, they're looking at $127,000 in fees plus at least that much
in equity. Anyone who has an interest in the long term growth of a startup is
doing everything they can to keep cash available for development, not shorten
the runway.

You're being distracted by something that isn't likely to put dollars in your
pocket.

Good Luck.

~~~
brudgers
> _"plus at least that much in equity."_

My bad. Should have known it was at least twice as much in equity since the
proposal was that the founders would keep a majority of the shares.

$3 million input is less than half the value. Ergo, a minimum of $6 million +
valuation (without considering an option pool) means that 4% equity has a face
value of at least $240,000.

Also, I am not certain that an S-corp allows for an 83(b) election in regards
to stock options (talk to an accountant) and make shareholders (e.g. founders)
responsible for tax upon the increase in the value of their stock. It could
result in a huge personal tax bill for the tax year in which funding occurred.
Again, talk to an accountant.

~~~
WiseWeasel
You've brought up several interesting points I'll have to look more deeply
into. It does seem like a good idea to discuss this with an accountant as
well. Thanks a bunch for taking the time to consider this!

