We call them “angels,” and for entrepreneurs striving to make their dreams a reality, finding a source of significant capital may indeed seem like a gift from above.
Unfortunately, when it comes to investing, “angel” can mean just about anything. Some investors just put up cash, while others mean to be involved in your company. Some angels try to negotiate very aggressive investment terms, which can make them seem more like dark angels. One of the most common requests is for an ongoing percentage of your company’s revenues or of its profits, with no cap on the upside and no phase-out provisions.
You don’t want to negotiate this on your own. Sure, you might avoid paying legal fees at first, but you’re likely to end up paying out hundreds of thousands of dollars later. And you can be stuck with someone who is entitled to a never-ending stream of profits, without necessarily contributing anything to your company.
This happened to one entrepreneur I know, who didn’t seek legal help when it came time to negotiate terms with the angel investor who helped fund his tea company. As the company grew, the angel ultimately reaped more and more cash while serving as a constant distraction and detracting significantly from the entrepreneur’s focus and productivity. There was no way, legally, to get rid of the angel. In the end, the entrepreneur had to offer the angel a very expensive buyout on top of all the profits the angel had reaped at his expense.
Sometimes, entrepreneurs see dollar signs and lose common sense. Don’t let the promise of capital lure you to act rashly. You should not give up more of a stake in your company than you need to, ideally not more than 5 to 10 percent. Remember, it’s a negotiation, and a very important one. You don’t have to take the first deal you’re offered just because there is fast cash at the other end.
Another friend of mine, a restaurateur, fell into this same trap. Early on, she gave one angel investor a fixed percentage of earnings in her first restaurant, with no caps on upside and no phase-out provisions. She didn’t realize she had other options beyond what the angel proposed. Ultimately, she gave up a huge share of her success and profits. She has opened subsequent successful restaurants, and never made that mistake again. Please, don’t you make it, either.