Ask HN: How To Avoid Getting Screwed By An Investor?

5 points by j_camarena 14 years ago | 4 comments

We are part of the 2nd generation at startup Chile program and that’s cool. The program is excellent and lots of doors are starting to open for our startup. Basically we do some kind of consulting for small and medium sized business in Latin-America that has been enough to achieve ramen profitability, rent office, buy equipment and been selected to participate in the program.

We have two months here in Santiago and a month ago we received an email from Startup Chile STAFF saying that some “small investors” where wanting to talk with us.

We did the 3 pitch, I think we did it great because they asked for a second meeting, we talked about details there and at the end of the meeting we scheduled a 3rd one for the next week.

This meeting was just yesterday and the investor said “YES, let’s start working”. We are a team of two guys, I do the “technical stuff” and my partner does the billing and taxes part... That’s great and is working but the problem is that I don’t know how to code and we want to build an application for our startup.

The investor is the CEO of a web development company in Santiago and he wants to partner with us. The deal is to have3- 5% of our company in exchange of building the application and some cash for us.

That’s a good deal.

I have thinking about this app for a while and by this point I have a lot of sketches about how the app should look and work. I just need someone to develop and the investor’s team can do this without a doubt.

He wants this sketches but I suppose is not a very good idea to show them without any signed contracts. He just gave us a NDA to sign but I don’t know what else we must do to avoid a story like this for us:

http://venturebeat.com/2012/02/27/a-classic-startup-horror-story-the-ma-bait-and-switch/2/

We have our next meeting on Thursday and I’m really in a hurry for advice about how to avoid “being screwed” by this guys… You know, I don’t want them to see the sketches, build the app and said “thanks for your cooperation guys, see you later”.

Any advice about what steps we should follow to avoid a “Horror story” Situation?.

brudgers 14 years ago |

Be aware that if you and your partner have the same level of ownership (e.g. the split is 48/48/4), your new partner has the same degree of control as either of you - i.e. any two stockholders have sufficient votes to screw the other one.

Second point is that the new owner's shares should vest over time with specific milestones - such as half for the cash and half for the completed app. Some sort of clawback related to the performance of the application might be a good idea.

My gut tells me that this sounds a little too good to be true - 4% for cash makes sense. Throwing in the programming doesn't seem justified, the NDA is also problematic when the person proposing it hasn't brought anything to the table which has an economic value associated with its disclosure.

The final point is that unless you are looking to bring on a partner, this is a distraction. If you have runway and are hitting your targets, you don't need necessarily need a partner. Then again, if you require one it is better to negotiate before you are near the end of your runway.

Good luck.

brudgers 14 years ago | |

After sleeping on my answer, I think it is important to think about the potential issues which can arise when:

1. An investor is also responsible for coding the core product. Multiple roles mean conflicting interests - e.g. protecting invested assets versus the risks associated with high growth.

2. A person with a minimal equity stake is responsible for coding the core product. It is easier for a person with only a few percentage points of equity to find a better opportunity or hedge their investment. 5% of a $10,000,000 sale is nice, but it's not going to allow a person to retire.

bdfh42 14 years ago |

First off - "he" gave you an NDA to sign but we are talking about your IP - so that's the wrong way around.

More important - if you don't feel you can trust this guy - then you should not do business with him. Simple - perhaps not logical - but gut feelings matter a lot.

rprasad 14 years ago |

Talk to a lawyer. Do not make legally binding decisions based on advice you get from the internet.

But as the other commenters have noted (including the dead guy): do not sign an NDA to talk with an investor. NDAs should not be part of the investment relationship. If they are, the fundamental trust necessary for a working relationship is absent and nothing good will come of it.