Investing in a startup might sound like a good idea because you know that you could see some substantial returns if the business takes off.
You also know that you're taking a big chance on any new entrepreneurial adventure. Although high risk can net higher rewards, even a private investor with deep pockets doesn't want to casually throw money around. That's why it's generally wisest to consult with a venture capital attorney before you commit to private equity funding.
What Should You Consider Before Committing Your Money to Any New Business Venture?
Unlike investing in an established company via stocks or loans where you can usually expect slow, steady growth from your investments, new companies are positioned in a way that could allow for a rapid return on your money. Alternatively, you could lose everything you invest just as quickly. That is why it's essential to:
- Clarify your role: Most venture capital funding contracts involving startups presume that the person supplying the funding will nurture the company's goals and guide its direction. You need to fully understand your limitations before you agree to provide any funds. You don't want to turn over your money and find out later you have no voice at all in what happens next.
- Assess the company's viability: Due diligence is always part of any sound investment strategy, but it takes a different process when you're looking at a startup. You may need someone to review the company's business plan and goals and make sure that they seem well-researched and attainable.
- Check the company's structure: It takes an experienced eye to look through the records of a newly-formed company to make sure that they actually have the right business formation to even engage in a venture funding situation so that neither you nor they are in violation of the law.
- Obtain the right financing documents: In order to avoid problems with securities laws, you need to make sure that all the financing documents are in place, including your investor rights agreement, term sheets, and any stock purchase agreements. You also need to know if you have the right of first refusal if other investors decide to sell their shares.
Finally, working with an experienced advocate can help you protect your investment in the future by looking ahead to potential problems. For example, you may want to establish protections through subsequent funding rounds by clarifying your enumerated rights or include a right of redemption that guarantees a buy-back on your investment under specific conditions.