Introduction

With the advent of technology, we get our information from a variety of sources. Mostly online. Legal advice is no different. Some consumers take to AVVO or other websites to seek out attorney answers to relatively simple questions. As an attorney, I try to answer a few questions from time to time as a service to that community. Recently I ran across this question:

Answering the question

Investing in someone's business (large or small) is a serious event that has caused financial windfalls for some, and financial ruin for others. It isn't anything like investing on the NYSE or NASDAQ. Public companies, and some private ones as well, need to comply with securities laws regulating the way third parties invest in companies. Your neighbor, son, daughter, or best friend's company likely falls into an exempted category of securities laws, and thus it is all the more important that you make sure you protect yourself.

The writer of the question above is in a tough spot. While he may be able to prove a verbal contract between the two using emails, text messages, etc., he would certainly be climbing uphill. All the while, if he/she decided to sue his alleged business partner, it is likely that this person may be using some of the investors money to fund his legal fees. His best option is to take his money back as fast as he can get it.

This example is the primary reason why you MUST hire an attorney to assist you in the preparation of proper documentation. While he may be entitled to more money for his alleged equity, he may also be entitled to less if the business has been losing money. As an equity holder, you share in the profits, and the losses of the company, and you may loose value of the principle amount you invested. 

For example, lets say you invest 10k into an emerging tech company owned by a friend. At the time, he provides you with a Cap Table, and some relatively reliable financials that illustrate your 10k represents 10% of his company that has a "Pre-money" or Pre-Investment valuation of 100k. 3 months go buy and the shareholders agree its time to sell the company. Problem is, the company is now only worth 50k to the highest bidder, even though by any reasonable person's standard, the leadership of the company was doing all the right things. The company is sold and you receive a check for 5k or 10% of the value of the company when it was sold. Generally speaking, you do not have a cause of action against the company or its leadership for your loss in value.

Alternatives to Equity Investing

While equity always sounds fun, it may not be the best thing for you. Sometimes debt securities are the best option. These include convertible notes and fixed/variable interest loans. Another alternative would be a secondary class of stock (preferred).

Any of these instruments must be tailored specifically to the investors needs, with some consideration given to the impact on the company. it is not recommended that you try to draft these types of documents on your own.

Conclusion

If you find yourself interested in doing some "angel investing", be sure to understand what you are getting into. One resource that will give you some basic insight is the TV show Shark Tank on ABC. The "Sharks" are technically known as "Accredited Investors" under securities laws based on their income, but that doesn't mean you can't learn from them. Listen to their questions, and ask yourself, "Why would they ask that question?"

When the time comes and you are interested in becoming a Shark or an Angel, or you have questions about this blog, feel free to Contact Us.