Beware Of Your First Investor

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We’re well aware of how critical it is for a startup to raise capital. I’ve yet to see a startup that can generate revenues without raising capital. This is the same for just about all small businesses besides service businesses.

Given how critical raising capital is, I see a lot of early-stage companies agree to less than friendly investment terms, just to get the capital in. While this initial capital can seem essential to the business, it oftentimes ends up being the death knell.

This doesn’t happen as much with traditional venture companies as it does with small businesses. The reason is that the mechanics of venture fundraising have been democratized in a sense, with the advent of shared resources and knowledge like SeriesSeed.com, Gust.com, NVCA.org, and the docs and doctrines promulgated by tier one accelerators like TechStars and Y-Combinator. As a result, early-stage venture companies have access to best practices, documents, and processes which can guide them from Friends and Family rounds to Angel rounds to Seed rounds and beyond.

But in the context of a small businesses, I still routinely see short-sighted investor terms like blanket anti-dilution rights, undefined future investment rights, and investor management controls which end up stifling growth and driving a wedge between the founder and investor. Or worse yet, I see debt investment structures that are inappropriate for initial funding rounds. Many times the terms are so taxing that they become a barrier to future rounds.

Thus, when you are seeking your first round of investment capital, make sure you think of it as just that – your first round. Consider each term’s effect on later financing rounds and its influence on potential investors down the road. You will likely need to raise again (either with other investors or by borrowing from a bank), and you don’t want your first set of terms to be your last.

About the Author
Kevin Vela

Kevin is the managing partner at Vela Wood. He focuses his practice in the areas of venture financing, M&A, fund representation, and gaming law.

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