NFT: Question about investing in a start up company (legal)

If their company doesn't work out, then you don't get any returns. If it does "ok," then you'll do OK, and if it does great then you're in danger of being bought out. I'd be really weary of investing in anything with a pre imposed ceiling.

do exactly what you fear it will do, to shed investors if it hits big. Don't agree to that.

...investment to me.

converts to shares, how do they force you to sell the shares? or am I missing something.

of buying him out before conversion to shares.

And be careful, anyone dumb enough to have you as a friend isn't likely destined for greatness.

The Social Network

Be very cautious mixing friends and business. You will usually end up with one but not the other, and sometimes neither.

they have lawyers, if they want your money mark it up and remove the clause.

If it is successful they will buy you out

seems to be a consensus (which I suspected there would be).

Thing is...I understand why they want the clause, but it should be explicitly stated what it would be used for. As presently stated, they could arbitrarily buy me out and I'd have zero recourse.

Much appreciated, enjoy your weekends.

you are...a lender not an investor. Your friend fibbed, probably on purpose.

unsecured lender

never heard of anyone putting this clause in because of chance that an investor would be determental to a company

it is quite the opposite you are the ANGEL to the company
you are assuming the financial risk and giving an unsecure loan to an unproven company

the very fact he put this in might be a reason to walk away

usually this it put into contracts because sometimes
a company can not get next round of financing until notes are retired rather than converted

but usually this clause also in includes that this convertion can only happen with Majority Holders approval

in other words all those who have convertible notes would have to approve this to happen
which of course they would never do ..

Even if they did specify only for deleterious conduct what constitutes that is not specified. Either it is removed completely or no dice on the investment

From a blog:

Quote:

To angels, prepayment defeats the entire purpose of making a convertible note investment in an early stage startup: A 6% or 10% return within a year or two isn’t worth the risk associated with making an unsecured, non-recourse loan to an unproven, development-stage company with little or no revenue. Investors want to see the company hit a home run, achieve an exit at a hefty valuation, and ultimately generate a 10x or greater return on their capital. Therefore, it’s unusual for the company to be permitted to prepay the Notes without the holders’ consent (again, typically a decision the Majority Holders can make on behalf of all noteholders). The one exception, which we’ll get to in Part IV, is if the startup is acquired before it closes a priced equity round; the company needs a way to retire the Notes in connection with a merger or acquisition, and investors will expect a decent return in that scenario.

I deal with people all the time who want to put in a clause that says X, but then they say they really only want it to accomplish Y. I always tell them that the clause should then say Y instead of X.

I'm not a startup lawyer, not your lawyer, and this isnt legal advice (ass: covered), but if I was in your situation I wouldnt agree to this and I'd tell them that if they insist on protection against me being a pain in the ass, maybe I'd agree to something where they can buy me out on commercially reasonable terms. The note could say that the parties will work to negotiate a transaction at fair value and failing agreement will submit to binding arbitration in front of a neutral (lawyer or valuation expert) that is either mutually agreed to or designated by a court or ADR agency (AAA, JAMS etc).
Link - ( New Window )

In comment 12042919 bob in tx said:

Quote:

you are...a lender not an investor. Your friend fibbed, probably on purpose.

No, convertible note holders in startups are really investors and not lenders. They are not on par with general unsecured creditors in bankruptcy (e.g. bondholders, suppliers). Your investment takes the form of a convertible note so that you get all the upside of holding equity (stock) while ALSO being in a better position than ordinary stockholders (you get paid first in liquidation/sale if the debt is more value than the equity).

or insist on increasing the penalty to a large enough percentage to where you would be comfortable with the return in the event that you were to be bought out.

to buddy fuck someone

that's an interesting idea and one my lawyer buddy floated. As it stands now, the return is meager and little more than what I could get with a blue chip stock.

Montana: there are 3 partners. I'm only friends with 1. I don't know to what degree my friend is responsible for the insertion of the clause. They're working, too, with a big shot lawyer from Boston who might be influencing their course. Regardless, I've not taken into account our personal relationship at all and am approaching this 100% from a legal/business perspective.

It is business so take emotions out of it. If you view it as a good opportunity don't get offended to where you lose out. The simple fact is you are risking your investment so with that in mind demand a good return as the penalty. That way you will be in a win/win situation if they succeed by either owning shares or being paid a handsome return of your money.

Hope it works out

and I've never seen this before on a deal. He should avoid investing in a company that would put that in there to begin with.

I would never sign a deal with that clause. If they truly mean what they say, then they should put a morals clause in writing rather than tell you what the spirit of the clause is, but leave it ambiguous in the document.

My number one concern as an investor is being squeezed out if the company is successful. I worked for a start-up where the owner squeezed out investors over several years. From what I understand this isn't common because it's an easy trip to a lawsuit (just look at Snapchat). My old owner got used and settled.

This clause gives the company a legal way to easily squeeze you out. I couldn't care less about the 7% interest on the note or a 10% buy out. The only reason in my mind to invest in start-ups is for upside. 7%, 10%, whatever, doesn't compensate for the risk the angel takes. That's why VC's don't get involved at this stage with big bets (although they did during the rise of the tech bubble). It's vaporware at this point.

This clause gives the company the right to fuck you. At this point they have lost my trust, even if they remove the clause, because I know they don't care about my interests.

Definitely talk with the attorney that specializes in this area. I know they will confirm what everyone else here has said. If you can get the clause removed, I would still have a problem with their mindset that led them to include this in the first place. However, if they pull it and you love the idea and feel the team is strong, I understand if you don't want to pass it up.

Good luck.

good points and I agree the very inclusion of the clause indicates that they don't have their investors' interests at heart.

I helped found a similar company a few years ago (although with a larger stake than the one in question) and I had a say in everything that went into the contract. We didn't finalize until all parties were satisfied.

It's a shame because it's a good opportunity, but my biggest fear as well is not loss of my principle, but of like you said being "squeezed out" if the thing takes off (which I believe it will).