Published in the San Diego Union-Tribune, December 23, 2019
The holiday season is often used as a golden opportunity to talk about peace and goodwill toward men, to remember the less fortunate, to spend time with family, to take stock of the past, to consider the future, to ask forgiveness for hurts inflicted on loved ones, to make commitments to do better to everyone in what is euphemistically known as the “new year,” and finally while roasting chestnuts and drinking egg nog, you will pause to think about mankind, the manger, the universe and how pitifully small each of us is in the grand scheme of things. OK, do you feel better now?
When the noisemakers and balloons are long gone, our startup entrepreneur will once again go looking for that angel investor (often referred to as friends, family and fools). However, it is important to understand some of the legal issues when dealing with investors.
Please note, I am not a lawyer, and I do not play one on television (“VCs in a Van”). Like all the medical advertisements on television that tell you to consult your doctor, I hereby and with vigor advise the entrepreneur to consult your lawyer. I did not say to consult Legal Zoom, nor your aunt Harriet who just graduated from law school, but has not passed the bar. California is quite favorably inclined in its protection of investors, and there are clear rules on how and from whom you can take money.
The primary theme is simple. Only take money from an accredited investor. Here is the legal definition. “In the United States, to be considered an accredited investor, one must have a net worth of at least $1 million, excluding the value of one’s primary residence, or have income of at least $200,000 each year for the last two years (or combined income of $300,000 if married — and have the expectation to make the same amount in the current year.” There you have it, word for word (more or less).
There may be nuances and possible maneuvers, but to quote a blog from a major law firm, in their discussion of taking money from an unaccredited investor, they say “you shouldn’t.”
The reason I am putting a stake in the ground here is that the chance that the investor will lose money in your deal is greater than 70 percent. That is the statistic across all deals, and it is worse in deals without a professional venture capitalist. If you take money from widows and orphans very bad things can happen. (Again, call your favorite attorney.)
Investing in startups has a death curve only slightly better than jumping out of an airplane with a chute packed by Edward Scissorhands. On the one hand, every entrepreneur has a deck that tells the investor that at least on paper, good things are lurking, and of course, along with his check, the investor signs a document where he acknowledges the risks and affirms that he can afford to lose it all. But if the company happens to get run over by a truck, the unaccredited investor may get a severe case of amnesia (and a good lawyer).
The startup roller coaster ride, even for professional investors, takes both a strong stomach and a touch of insanity to get in that car again and again. With one hand you are painting a unicorn, and with the other you should remind them to run for the hills. Enough said.
Allow me to temper the above darkness with equal wonder and amazement and loud applause for the great companies locally, the significant investments being made and the outcomes that have been enormously successful. The Union-Tribune and the San Diego Business Journal call out these wins every day and every week. Those wins keep the flame alive; those stories of triumph fuel the dream of an outsized return.
I love the game. I love the entrepreneur, the scientist and the dreamer. But it is still a game that resembles catching falling knives. Be very diligent in explaining the risks to Uncle Harry, and if he decides to invest, then he should think of it as a partial advance on your future inheritance. Best wishes for peace and wisdom. I will be back in January.
Rule No. 640