(Caveat: I am not an attorney, accountant, or licensed professional in any regard; before contemplating any financial transaction, you should seek the advice of trusted professionals. The following is strictly my opinion.)
I saw an interesting deal this week which didn’t make me very happy. A second stage start-up that I am aware of filed for bankruptcy, of the liquidation ilk.
My guesstimate is there is about 500k in debts from creditors; there are virtually nil assets, except some (possibly) items and fixtures that can be sold at liquidation to satisfy the creditors who may receive percentages of pennies on the dollar.
Here’s the rub. The entrepreneur has provided a series of promissory notes dating back several years – that he lent money to the company during the start-up phase and is the only “secured” creditor, and thus is entitled to be in charge of the sale of the goods and receive the majority portion of the proceeds.
“Legally”, there is probably some element of truth to this. Morally, not so much.
Traditionally, while entrepreneur’s “skin in the game” is always the first money in, it’s also (supposed to be) the last money out.
In the train wreck of this business, there will be a lot of very small vendors, employees, and advisors that are going to be hurt hard.
It just doesn’t seem right.
So the point of this post, is if you are contemplating an angel investment into a start-up, spend the money to conduct a thorough due diligence. Do not invest on a whim, or at the behest of a relative’s or friend’s pleading. Make a sensible decision based on facts and the information available to you.
If you are offered a convertible note (often the case in start-ups), make sure you are listed as a secured creditor, with rights second to none.
Ask for an ‘early buy-out’ clause, that is, if major funding comes along, you have the right to exit the deal early.
You’ve heard it a million times – if it sounds too good to be true…