Give seed investors too many rights, and it could hurt your ability to raise money later. Below, five deal items mom and dad can live without.
- Ratchets A ratchet automatically awards extra shares to prevent your original investors from having their stakes diluted. If you've given these to seed investors, get them to give them up--or forget about raising VC funds.
- Preemptive rights Related to ratchets, preemptive rights give investors the option to buy more shares during a subsequent round, thus maintaining a large stake. Remind friends-and-family investors that small is beautiful. Dilution is not necessarily a bad thing if the company's overall value increases.
- Liquidation preference Shareholders with this status get paid first in the event that the company is sold or goes bankrupt. This will decrease your chance of a windfall and put off VCs, who almost always demand that they get paid before your seed investors do.
- Veto rights These give friends and family the right to veto a subsequent investment. Most professional investors will force you to waive veto rights before beginning negotiations.
- Board seats It's okay to create a board that contains seed investors, but friends and family should understand that they'll probably have to give up their seats in the event of a deal.
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