Should I invest $100K in a startup for 3% equity? – pre money valuation is $20M
12 comments
First off, you should retain an attorney and ask that attorney all of these same questions. This is non-negotiable. You will want this moving forward.
If the contract for this transaction is sound (refer to the "Get An Attorney" section) then you are buying 3% of the company at $3.34mm valuation and, if the seed money comes through at the amount and percentage you state, you have 6x'ed your investment. That's not a bad deal. However, there are some caveats. It all smells fishy.
First, this company has been in business for 3 years or so and they have not seen a profit until last month? Their valuation is effectively $0, especially if they are in the consulting space and not the product space. They have no assets. They make no money. They have essentially no history of being successful. I am not suggesting that they have no hope of becoming successful, just that they currently should not be valued at $3.34MM. That would be 13 times annual gross? No way.
Second, we can extrapolate that they are not worth $20MM. You mention that they were cash positive last month for the first time. Let's say that means they made $35k on a $30k burn. Let's also say they can keep at that level, month over month. At a $20MM valuation they are being valued at 47 times annual gross? No way. The investment firm will learn this quickly as they do their due diligence.
Third, let's look at debt. They aren't paying you. How many other 1099 contractors, vendors, and others are they behind payments on? Do they account that debt and those payments into their $30k monthly burn? I will not speculate, but if you are planning to invest $100k into them, you should know for sure.
If you were going to invest $100k into a company like this, I would suggest a much lower valuation. I would also suggest that you get a board spot. I would not be shy about asking for a stepped up equity position under various circumstances (The other investor doesn't come through? More equity for you. You spend more time working for the company? More equity for you. etc). Say 10% equity for $100k. another 10% if the seed money doesn't come through. X% annually as you help them grow the business over the next 4 years.
Now, if it were me, I would never invest in this deal. $100k is enough to invest in my own successful business without the baggage. I would leave, invest in my own company, and sue them for my unpaid work. But, that's just me.
If the contract for this transaction is sound (refer to the "Get An Attorney" section) then you are buying 3% of the company at $3.34mm valuation and, if the seed money comes through at the amount and percentage you state, you have 6x'ed your investment. That's not a bad deal. However, there are some caveats. It all smells fishy.
First, this company has been in business for 3 years or so and they have not seen a profit until last month? Their valuation is effectively $0, especially if they are in the consulting space and not the product space. They have no assets. They make no money. They have essentially no history of being successful. I am not suggesting that they have no hope of becoming successful, just that they currently should not be valued at $3.34MM. That would be 13 times annual gross? No way.
Second, we can extrapolate that they are not worth $20MM. You mention that they were cash positive last month for the first time. Let's say that means they made $35k on a $30k burn. Let's also say they can keep at that level, month over month. At a $20MM valuation they are being valued at 47 times annual gross? No way. The investment firm will learn this quickly as they do their due diligence.
Third, let's look at debt. They aren't paying you. How many other 1099 contractors, vendors, and others are they behind payments on? Do they account that debt and those payments into their $30k monthly burn? I will not speculate, but if you are planning to invest $100k into them, you should know for sure.
If you were going to invest $100k into a company like this, I would suggest a much lower valuation. I would also suggest that you get a board spot. I would not be shy about asking for a stepped up equity position under various circumstances (The other investor doesn't come through? More equity for you. You spend more time working for the company? More equity for you. etc). Say 10% equity for $100k. another 10% if the seed money doesn't come through. X% annually as you help them grow the business over the next 4 years.
Now, if it were me, I would never invest in this deal. $100k is enough to invest in my own successful business without the baggage. I would leave, invest in my own company, and sue them for my unpaid work. But, that's just me.
Obviously you have way more information about this, but judging from what you've disclosed, it's a terrible investment.
Stock in a company is worthless (literally, as in "worth $0") until 2 things happen: * the company gets sold * the company does an IPO
Those are hard for all kinds of companies but next to impossible for a consulting company.
Consulting companies don't scale they way product companies do.
Revenue of $20k/month is nothing (this is what Google spends on a good engineer per month). They don't make enough to pay you a market rate.
How is this company going to ever get to multi-million dollar a year profit (a condition necessary but far from sufficient for a sale or IPO) ?
You seem to be so pre-occupied with details of the deal that you seem to be missing the obvious thing: investing in this company looks like a terrible idea because there's no way this company is going to be so successful to warrant a sale or IPO.
Stock in a company is worthless (literally, as in "worth $0") until 2 things happen: * the company gets sold * the company does an IPO
Those are hard for all kinds of companies but next to impossible for a consulting company.
Consulting companies don't scale they way product companies do.
Revenue of $20k/month is nothing (this is what Google spends on a good engineer per month). They don't make enough to pay you a market rate.
How is this company going to ever get to multi-million dollar a year profit (a condition necessary but far from sufficient for a sale or IPO) ?
You seem to be so pre-occupied with details of the deal that you seem to be missing the obvious thing: investing in this company looks like a terrible idea because there's no way this company is going to be so successful to warrant a sale or IPO.
Thanks a lot everyone for an amazingly prompt response. I did leave some important details.
The CEO is a serial entrepreneur - he has sold 2 companies to Autodesk and 1 to IBM in the past. He has enabled investors to realize exit profits in the US$180 million range with his founding team member involvement. He is also a highly rated and a well renowned speaker - this is how he gets business. Also, yes - they have been consulting so far but along the way, they have several prototypes developed (to be evolved to full products dependent on funding). I guess thats where the valuation comes in.
Someone1234: I like your idea of not putting all eggs in one basket. I think he did PMV at worthworm.com. Also, the fact that someone is willing to invest $2M - 10 multiple of the seed amount is $20M. Is this how you typically validate the PMV? And yes, one of my incentives to invest is to get myself paid. Is that a good approach?
kkowalczyk : I agree consulting companies cannot scale that much. But, this is positioned to become a product company (dependent on $2M funding) - in that case, what are your thoughts?
Jeffmould: The CEO has confirmed I will be at the top of the stack. Future funding will not dilute my equity. I like your idea of convertible debt to safeguard my investment. In fact, the CEO did mention this to me - he will take this investment as a loan to be returned to me - maybe he meant convertible debt? Is there anything more I should watchout for?
auganov: Thanks for your honest answer. I don't blame you as I left out the relevant details earlier. But how can I ask for 15% for only $100K when Mr. $2M is asking only for 10%?
lxfontes: Yes, if the $2M seed comes through, they have offered me a full time employment with some common stock but without the founder shares. Founder shares will only be given with cash investment.
The CEO is a serial entrepreneur - he has sold 2 companies to Autodesk and 1 to IBM in the past. He has enabled investors to realize exit profits in the US$180 million range with his founding team member involvement. He is also a highly rated and a well renowned speaker - this is how he gets business. Also, yes - they have been consulting so far but along the way, they have several prototypes developed (to be evolved to full products dependent on funding). I guess thats where the valuation comes in.
Someone1234: I like your idea of not putting all eggs in one basket. I think he did PMV at worthworm.com. Also, the fact that someone is willing to invest $2M - 10 multiple of the seed amount is $20M. Is this how you typically validate the PMV? And yes, one of my incentives to invest is to get myself paid. Is that a good approach?
kkowalczyk : I agree consulting companies cannot scale that much. But, this is positioned to become a product company (dependent on $2M funding) - in that case, what are your thoughts?
Jeffmould: The CEO has confirmed I will be at the top of the stack. Future funding will not dilute my equity. I like your idea of convertible debt to safeguard my investment. In fact, the CEO did mention this to me - he will take this investment as a loan to be returned to me - maybe he meant convertible debt? Is there anything more I should watchout for?
auganov: Thanks for your honest answer. I don't blame you as I left out the relevant details earlier. But how can I ask for 15% for only $100K when Mr. $2M is asking only for 10%?
lxfontes: Yes, if the $2M seed comes through, they have offered me a full time employment with some common stock but without the founder shares. Founder shares will only be given with cash investment.
Thinking about this even more, the company is only cash flow positive because they are not paying you. And if they are not paying you, the question begs who else are they not paying.
Just because the CEO has sold multiple companies and realized profits for previous investors, does not automatically make this a golden egg as well.
Finally, just because the CEO says you are at the top of the stack and future funding will not dilute you, does not mean it will not happen. In fact it is fairly certain to happen if additional, bigger investors come on board. If you want to get an idea of the dilution, Google an Excel cap table example (there's actually a pretty good one on http://cooleygo.com) and play with the numbers a bit.
I would honestly skip the whole deal, push for either them to pay you what you are owed to date or go with a convertible note. I would also talk to an attorney before I made any decision. It just seems to me that the CEO is trying to make it sound like a great deal with no risk, when in essence the risk is enormous.
Just because the CEO has sold multiple companies and realized profits for previous investors, does not automatically make this a golden egg as well.
Finally, just because the CEO says you are at the top of the stack and future funding will not dilute you, does not mean it will not happen. In fact it is fairly certain to happen if additional, bigger investors come on board. If you want to get an idea of the dilution, Google an Excel cap table example (there's actually a pretty good one on http://cooleygo.com) and play with the numbers a bit.
I would honestly skip the whole deal, push for either them to pay you what you are owed to date or go with a convertible note. I would also talk to an attorney before I made any decision. It just seems to me that the CEO is trying to make it sound like a great deal with no risk, when in essence the risk is enormous.
If the CEO is such a big success, where the fuck's his Ferrari?
And if he has a Ferrari, where the fuck are your consulting fees?
And if he has a Ferrari, where the fuck are your consulting fees?
My understanding is that you're going to join as a full time [somewhat critical] employee? Take a stroll around angel.co jobs. 2-3% for an employee is pretty common at small startups that already have funding. Even 5% at times. And that is for engineers.
The 2M is not there yet. It would only make sense if they agree that your investment only goes through if the 2M does. VCs love doing that. If they agree, then yes, I wouldn't consider the 3% a super unfair deal. But you still need to ask for employee equity @3%-10% depending on how critical to them you'd be. And I'm not even considering the money they owe you. Without the 2M guarantee I'd multiply everything by 1.5-2.
But still, I wouldn't do that deal, just no.
EDIT: just read the part about the CEO having a good track record. If that person is fully dedicated, you have trust in them and can verify their past then yea, the mainstream "market rules" don't really apply anymore. But still - negotiate. Or run :D
The 2M is not there yet. It would only make sense if they agree that your investment only goes through if the 2M does. VCs love doing that. If they agree, then yes, I wouldn't consider the 3% a super unfair deal. But you still need to ask for employee equity @3%-10% depending on how critical to them you'd be. And I'm not even considering the money they owe you. Without the 2M guarantee I'd multiply everything by 1.5-2.
But still, I wouldn't do that deal, just no.
EDIT: just read the part about the CEO having a good track record. If that person is fully dedicated, you have trust in them and can verify their past then yea, the mainstream "market rules" don't really apply anymore. But still - negotiate. Or run :D
I don't feel competent to contribute here essentially to the discussion, but one thing I noticed in the past is, that people often create consulting companies as "placeholder" spots. Meaning they are good at creating "real" businesses and when there is no high profile project for them to work on, consulting is a way that makes them feel busy. Not sure if the CEO is that kind of a person, but I would consider that option especially because of the "serial entrepreneur" background.
What kind of product is it?
A consulting business isn't really worth what you are proposing -$300k a year with a valuation of > $1m.
If I am understanding you right, if you invest $100k into the company, they would use that money to just pay back your consulting fees right? Why not have them compensate you outright stock and forgo cash compensation? It seems like a waste of time to put cash into the company and then pull the cash back out.
Also if you are concerned with them not raising the funding you could just make your investment contingent on the raise. Basically say to them "assuming that we can get this round done, I'm in for $100k". As an entrepreneur I hate this (makes me think you are betting against the company) but I could be persuaded if you picked up the axe and charged into battle with me. So make sure that if you do this you are busing ass trying to make the round happen.
A consulting business isn't really worth what you are proposing -$300k a year with a valuation of > $1m.
If I am understanding you right, if you invest $100k into the company, they would use that money to just pay back your consulting fees right? Why not have them compensate you outright stock and forgo cash compensation? It seems like a waste of time to put cash into the company and then pull the cash back out.
Also if you are concerned with them not raising the funding you could just make your investment contingent on the raise. Basically say to them "assuming that we can get this round done, I'm in for $100k". As an entrepreneur I hate this (makes me think you are betting against the company) but I could be persuaded if you picked up the axe and charged into battle with me. So make sure that if you do this you are busing ass trying to make the round happen.
IANAL, or an accountant for that matter, but something does not add up or you are leaving a lot of detail out. If you invest $100K for 3%, then the investor comes on at $2M for 10% you are going to take a hefty dilution from that. Without knowing all the details of the company or who/what they do, I am skeptical that a company only generating $20-25K monthly from consulting revenues is getting a $20M valuation. That seems a bit high for a consulting company that has been in business for 3 years doing less than $500,000 annual sales.
From the sounds of it, they are only asking you to invest so they can turn around and pay you from your investment.
With that in mind, you may want to consider doing a convertible debt and if/when investors come on you have an option to convert to equity or collect what is owed to you. And if the investor does not come through, the company still has a debt to you.
From the sounds of it, they are only asking you to invest so they can turn around and pay you from your investment.
With that in mind, you may want to consider doing a convertible debt and if/when investors come on you have an option to convert to equity or collect what is owed to you. And if the investor does not come through, the company still has a debt to you.
If he has had multiple exits worth any considerable cash, why doesn't he just put in the money himself instead of getting investors, especially an investor like you. Seems like he himself is not confident in his idea and doesn't want to risk his own money in the venture.
> especially an investor like you
This is a good point, at 100k for a round you're very friends and family sized, and the responsible question is, are you a qualified (legally and financially planning wise) to lose this much money.
This is a good point, at 100k for a round you're very friends and family sized, and the responsible question is, are you a qualified (legally and financially planning wise) to lose this much money.
They're certainly making you a better offer than the $2m/10% individual. That person is effectively paying $200K/1%, as opposed to your $100K/3% deal.
I would say consider this two separate deals, don't conflate them(!):
1) The investment: You're out $100K and have a fairly risky investment in this company that could be worth $0 one day (and no set payback date). $20m valuation is meaningless, it just helps you vaguely judge risk, but not much (also who did the valuation? How confident are you in them? Who is the 2m investor? Do they even exist?).
2) The full time employment: A full time employment offer, when or if, that happens should be considered on its own merit (although that alone sounds almost like a further investment as I imagine they're going to "under" pay you since you're now a stakeholder, or worse expect free work)
The ultimately question you should be asking is: Can you afford to lose 100K outright? Because that is on the table. Could you put that 100k on black on the roulette wheel, and risk a 50/50 shot of losing it? Or worse on a 1/16 or 1/32 shot. Because that is the reality.
To be honest I'd consider taking a 3%/100K if I could afford to lose (completely) 100K (and the company had good prospects). But I wouldn't work for them below market rates, because then the risk has risen too much, and it sounds like you do pretty well anyway on your consulting.
So if I did the investment I would then go and make money elsewhere, so that even if this company burns to the ground, my maximum liability at that stage is "only" 100K, not a penny more.
Working for them for 50% of normal or worse not getting paid reliably (as now) is just more and more investment and before you know it you might be throwing another 100k or 200K after your initial investment just from lost wages alone. Essentially trapping you into more and more risk.
So look at risking it on the company but curtail the level of risk. You shouldn't be in as deeply as a founder, your potential compensation isn't high enough.
I would say consider this two separate deals, don't conflate them(!):
1) The investment: You're out $100K and have a fairly risky investment in this company that could be worth $0 one day (and no set payback date). $20m valuation is meaningless, it just helps you vaguely judge risk, but not much (also who did the valuation? How confident are you in them? Who is the 2m investor? Do they even exist?).
2) The full time employment: A full time employment offer, when or if, that happens should be considered on its own merit (although that alone sounds almost like a further investment as I imagine they're going to "under" pay you since you're now a stakeholder, or worse expect free work)
The ultimately question you should be asking is: Can you afford to lose 100K outright? Because that is on the table. Could you put that 100k on black on the roulette wheel, and risk a 50/50 shot of losing it? Or worse on a 1/16 or 1/32 shot. Because that is the reality.
To be honest I'd consider taking a 3%/100K if I could afford to lose (completely) 100K (and the company had good prospects). But I wouldn't work for them below market rates, because then the risk has risen too much, and it sounds like you do pretty well anyway on your consulting.
So if I did the investment I would then go and make money elsewhere, so that even if this company burns to the ground, my maximum liability at that stage is "only" 100K, not a penny more.
Working for them for 50% of normal or worse not getting paid reliably (as now) is just more and more investment and before you know it you might be throwing another 100k or 200K after your initial investment just from lost wages alone. Essentially trapping you into more and more risk.
So look at risking it on the company but curtail the level of risk. You shouldn't be in as deeply as a founder, your potential compensation isn't high enough.
No.
The $2M is complete bollocks and they need the 100k to keep going until they can find some actual investment. Otherwise they'd be paying your bills.
So tell them you'll consider it once they pay you - and get some kinda signed statement that they do, in fact, owe you for two months consulting.
Frankly, it smells bad and for me that's enough.
The $2M is complete bollocks and they need the 100k to keep going until they can find some actual investment. Otherwise they'd be paying your bills.
So tell them you'll consider it once they pay you - and get some kinda signed statement that they do, in fact, owe you for two months consulting.
Frankly, it smells bad and for me that's enough.
short answer: I wouldn't do it.
1. I would ask for my unpaid consulting fees
2. Ask if they want me to join without the 100k down and take less % on shares
The rationale here is:
- Low monthly revenue for a long time
- Not paying contractors is bad
- How many other people have this 'offer' on the table?
If I were to put 100k of my money somewhere, it would be on a 1-year sabbatical and start my own thing.
1. I would ask for my unpaid consulting fees
2. Ask if they want me to join without the 100k down and take less % on shares
The rationale here is:
- Low monthly revenue for a long time
- Not paying contractors is bad
- How many other people have this 'offer' on the table?
If I were to put 100k of my money somewhere, it would be on a 1-year sabbatical and start my own thing.
I would not give $100k to anyone who didn't pay me and didn't tell me until after I had done the work.
You could cut out the middle man and just pay yourself. Anyway 3% isn't a controlling interest and you are entirely dependent on their goodwill in any liquidity event.
You could cut out the middle man and just pay yourself. Anyway 3% isn't a controlling interest and you are entirely dependent on their goodwill in any liquidity event.
Investing on the hope that they will use the money to repay what they owe you is pants-on-head retarded.
Option #1 - convert the debt to equity at the proposed valuation.
Option #2 - get paid, don't invest
Option #3 - expect to never get paid - walk away or continue for fun
Don't give those fools money. Working for 2 months without getting paid is enough of a gift.
Option #1 - convert the debt to equity at the proposed valuation.
Option #2 - get paid, don't invest
Option #3 - expect to never get paid - walk away or continue for fun
Don't give those fools money. Working for 2 months without getting paid is enough of a gift.
OMG NO.
3% would be a bad deal even for a regular employee considering they don't have money to pay you. If you really want to do it you should ask for 15%+. But please, don't.
Do you even trust these people? Unless we're missing some important information they sound either ignorant or shady.
3% would be a bad deal even for a regular employee considering they don't have money to pay you. If you really want to do it you should ask for 15%+. But please, don't.
Do you even trust these people? Unless we're missing some important information they sound either ignorant or shady.
I have been consulting for them for 4 months now. After 2 months, I realized they don't have the cash to pay me for my consulting fees. However, since I believe so strongly on their product / services / business model, I decided to stick. In return, they offered me to do a cash investment around $100K for a 3% equity (undiluted founder shares). With this cash influx, they plan to start paying back my consulting fees arrears. Also, with the $2M funding, they are offering me to become a full time employee with executive role.
I'm looking at this from a long term perspective. What attracts me is the 3% equity in the company and with my 100K investment, they will start paying my consulting fees monthly. I'm not able to decide if this a good deal for me? Also, what happens if the $2M funding does not come through? Ultimately, how can I protect my investment? With my investment, should I also ask to become a board observer?