Raising Capital

Constructing an elaborate set of agreements that confer special rights on friends and family is not customary, for good economic reasons. Not enough money is around to have the lawyers negotiate, say, a convertible preferred stock deal with all the usual bells and whistles. Generating capital is the idea, not sucking it up in concessions granted to your investors. That being the case, what special consideration should you give family and friends? Well, no one right answer to that question will apply in every situation, but a couple of suggestions are definitely in order.

Obligate your company to give frequent reports, as often as quarterly, to all your investors. Nothing is more annoying to a private equity investor than sending a check to an early-stage company and then hearing nothing further until the entrepreneur either hits a home run or strikes out. Be sure to require that unaudited financial statements and other pertinent information (how the company is doing against plan, for example) are sent to investors periodically and on time.

Your investor's circumstances may change, and the investment may no longer be appropriate for him or her or (perish the thought) for his or her estate. Set up a mechanism, sometimes referred to as a buy-sell agreement, whereby the individual investor and/or his legal representative (the executor of the estate, for example) have the right to put (sell) the investment back to the company when a death or other significant change (such as a disability or bankruptcy) is involved. The company may have a right to call (buy the investment back) as well. The call is, in fact, generic in the typical case in the form of a restriction on transfer. In the case of an investor's death, the company usually has a first call on the stock, and then other investors are given a chance at any left over stock.

Buy-sell agreements are relatively simple. They set up a system for appraising the investment's fair value as of the time the purchase or sale is exercised and they create a mechanism to carry out the transaction. Because these are long-term, highly illiquid investments, particularly in the early stage, you need to anticipate the worst case that circumstances will change so significantly that separation is called for.

A buy-sell agreement usually enables the company to pay off the agreed-upon amount over time because the company may not be in possession of enough cash to make a lump-sum payment. An interest-bearing note secured by the stock being put to or called by the company is a typical instrument.