The Investment Trade-Off
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Question: We've been looking for capital from investors for several months, but it's been difficult given the current market conditions. We just met with a potential investor who's interested in giving us money, but he wants a role in running the business as well. Do you think that's a good idea?
Answer: Taking money from an investor who also works for your company can be tricky, so no matter how badly your company needs the cash, you have to think through the pros and cons before signing on the dotted line. For starters, an investor who's also an executive may act more like a boss than a partner. What's more, it may be difficult, if not impossible, to fire an executive who owns a big chunk of your equity. That's why Tim Sciarrillo, founder of consulting firm The New England Group Companies LLC, warns that "each situation must be analyzed individually, and many factors must be taken into account to avoid pitfalls." Even if you and your new partner get along fine, failing to structure an arrangement like this properly--and trying to do it yourself without consulting an attorney or accountant--can lead to tax problems down the road, as well as securities violations and lawsuits.
Sciarrillo says the key to making a deal such as this work is to create an equity-sharing structure that's a win for both sides. Grants of stock, while attractive to your investor, can dilute your ownership and give the executive/investor immediate control over your company's decisions. "Options [by contrast] can be as valuable as stock and can be issued in any amount," Sciarrillo says. "If the company issues options, they don't immediately dilute the shares. And the investor can participate after the money has been invested based on the option price set, making the return more aligned with future company performance."Rosalind Resnick is founder and CEO of Axxess Business Consulting, a New York City consulting firm that advises startups and small businesses, and author of Getting Rich Without Going Broke: How to Use Luck, Logic and Leverage to Build Your Own Successful Business. Reach her at firstname.lastname@example.org or through her website, abcbizhelp.com.