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An 'Investor' Destroyed My Startup

39 points by _tmel ↗ HN
Let my experience serve as a valuable lesson to entrepreneurs - do your due diligence on investors.

I spent a little over a year and $20,000 of my own capital building a FinTech software. It demonstrated a lot of interest and potential (E.g. a $5 B company was reviewing our product prior to launch to be a client) , but rather wrapping it up and getting revenue to raise money from Tier 1/2 VCs, I had an offer from an investor to put in $1 M at an unattractive valuation.

Myself thinking, 'I don't care about the valuation, I just want to get the money in to accelerate', I accepted - despite being in various stages of due diligence with three investors. After several months of negotiations and many calls a legal agreement was formed... The important lesson here is the 'hidden valuation', that is, in the value of the quality of your investor.

Usually when an investor signs a term sheet, the money comes through relatively quickly and things accelerate, but week after week, and excuse after excuse the money never came in. During this period, having expected the money to come in, I hired my top developers full-time and am now stuck with those expenses - unable to comfortably afford it.

Now, I'm stuck with a rouge 'investor' owning 50% of my company without putting in any a dime, close to $10,000 in bills, and a software I poured a year of my life into and made many sacrifices for. At this point, if I were to raise more money, I would have less than 20% of my company on the first fundraising round (assuming giving a real investor 20 - 25%).

Despite this, the people you have on your cap table and relationships between them can send most top investors 'running for the hills', they don't like drama and founders with little equity - as it decreases motivation and means they can't negotiate attractive valuations for themselves. As much as I would like to admit - this is almost certainly game over.

Had I conducted even slight due diligence, this could have been solved. If I had held out longer and got a little traction, I could have appealed to Tier 1/2 VCs, rather than risk doing business with an unknown entity.

I should also note, I have a background in PE/VC myself, I'm not a fresh entrepreneur either. It's easy to be blinded by logic when someone offers you capital for investment. As a note to all people intending to raise capital - don't be blinded low hanging fruit because it's often, but not always - toxic.

44 comments

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[dead] twervle
Sounds like you're frustrated and also know it's you got you into this.
vikramkr
Thank you for sharing your story! If the investor didn't put in the money, then surely that's terms for breach of contract, you should be able to kick him out of the cap table. And if your best developers still believe in your vision, maybe they'll be willing to take a pay cut in return for equity if they understand the situation and want to help you work it out? I guess a lesson here is that its not done till it's done and theres money in the bank, but in that same vein, it's not done until theres money in the bank, and if there isnt, then you might still have a path forward to salvage it and return it to it's rue potential.
_tmel
Traditionally, yes, but the investor insisted on clauses that were structured in a way for them to retain equity without being obligated to put in money.
unknownkadath
Might get a lawyer to kick the tires on the contract language. I mean, ianal, but that cant be legitimate, can it?
gus_massa
I agree. Get a lawyer.

@OP: Did you have a lawyer to review the weird clause before signing it? Was it your lawyer?

closetohome
Contract: Investor gets 50% of company. Company might get money someday but no guarantees.

OP's lawyer: Sounds legit to me.

digitaltrees
Get a better lawyer. Doesn’t sound like an enforceable contract.
thatoneuser
Dude... Not to be a dick but you claim you have experience yet you're signing away half your company without seeing a dime and with clauses that explicitly state they don't ever have to actually pay you? None of this adds up. I have zero experience with getting funding and even I'd insist on a 10% down payment minimum. Otherwise wtf was the point of getting an investor?
hughes7370
There are many conditions in which this structure is entirely reasonable. However, it gets down to the investor and their track record history. I take fault for not doing due diligence and probing them. Namely:

1. Ask for references of prior companies they have funded.

2. Identity mutual contacts with someone you both know and can verify their credibility.

3. Ask around their reputation of other VCs and people in the space.

zwily
Can you describe some of the scenarios where that makes any sense? Sounds bonkers to me too.
vikramkr
It is bonkers unless theres something not being explained.

https://en.m.wikipedia.org/wiki/Consideration_under_American...

An illusory promise does not count as consideration, and the courts would probably force the investor to pay up the money or, if there were no promises made, the co tract could be overturned on grounds of lack of consideration.

gitgud
When would this be reasonable? It sounds like Zero risk for the investor... promise money in the future in return for equity, if the idea flops they've lost nothing... ridiculous
hughes7370
The way it was structured would have allowed him tax avoidance on the investment, but also not be considered an investment but rather a silent cofounder, which would allow me to accept a low valuation without having a negative impact on the next round. Otherwise, it needs to be explained why the valuation was so low.
vikramkr
That still doesnt make sense. Was there no clause that said that he had to put in the money? And why is it a big deal to explain why the valuation was so low? I'm really co fused by what the reasoning was or even why you would spend time on closing this deal if, as you said, you had other term sheets lined up and have experience in this. Is there something we are missing here? Like is this not in the US or was the money desperately needed or something? The takeaway seems to be less about doing due diligence on investors and more about avoiding insane contracts- I'm still having trouble figuring out what exactly even happened. Thank you again for sharing this experience with us - I'd really love a bit more context if you wouldn't mind so I can understand the takeaways better. And in the meantime definitely get a lawyer.
woah
In the US, you can’t buy something without paying for it. Did you give your investor the equity as a gift?
quickthrower2
You can’t list something for free on Craigslist? And have someone pick it up?
vikramkr
Not a lawyer, but I believe that just giving something away is not technically enforceable which is why you see 1 dollar price tags, and picking it up would count as payment if the person giving it away is trying to get rid of it, the value is kind of in the garbage disposal aspect. And its not that you cant list or pick up stuff for free, you bn obviously can, but you just might not be forming a legally enforceable contract
janetacarr
For those wonder how something like this can happen I have a theory. It's possible the stock 'purchase' agreement didn't offer capital as consideration for equity; rather, stock would be assigned to the 'investor', and the 'investor' would 'confer' capital to the company which requires no obligation by the 'investor' to provide the capital.
vikramkr
I looked up the word confer in a couple online legal dictionaries, and if they are reliable, then it seems the word confer means "give, accord, administer, award" etc which would be an obligation to provide capital right? I'm curious how your structure would work in detail - I imagine there must be loopholes in contract law and consideration requirements and yours sounds interesting.
digitaltrees
People can write whatever they want in a contract, that doesn’t mean it’s enforceable, or will stand up to scrutiny in court. Contracts have to have consideration. That means there must be something of value each party gives to the other.
digitaltrees
Contracts have to have consideration (something of value exchanged between both parties). Get a lawyer, fight this. The existence of your company is not something you should just concede, and honestly, this should t take you down, your investor will lose. Or just form a new company, and buy the assets from the old company and move on with your life.
DevX101
Sorry to be crass here, but what kind of bullshit lawyer did you hire that let this pass?
bcb1276
I’m a lawyer. This doesn’t make sense. What exactly did the clauses say? Did the “investor” make his (non) investment contingent on some types of conditions precedent that you didn’t meet? If yes, then he doesn’t have to fund his investment. But he doesn’t also get his equity. If no, then he breached and you have a claim against him.

I would not treat him as an investor and instead talk to a lawyer about putting him on notice that you’re prepared to sue him for tortious interference with your business. The other comments here about the requirement of consideration are correct. Also relevant: unjust enrichment and restitution [0]

I’m 100% speculating because you haven’t supplied enough information. The most important part of your post should be the actual language.

[0] https://en.m.wikipedia.org/wiki/Unjust_enrichment

manishsharan
Did you have an attorney ? One of the most valuable lessons I learn is that lawyers are really important for founders -- perhaps even more important than co-founders.

My advise would be to fire the developer and hire the best attorney you can afford.

icedchai
Okay, so the guy didn't give you any money, yet he now owns 50% of your company. You basically gave it away for nothing. How is that possible? Did a lawyer review this agreement?

Form a new company, transfer the IP, forget this guy.

_tmel
Yes, that sounds like the plan.
renoir42
Indeed. Use know how, recode in another language if needed, screw the a*e.
quickthrower2
How is it possible to transfer the IP if there is another partner who won’t agree to that? A lawyer would be needed on that one but surely it’s cleaner to void the contract.
icedchai
It depends on his agreement. He may have the authority to do it.
toweet
Ouch. So sorry to hear. What are you planning on doing at this stage? If the contract you signed is airtight, what next?
hughes7370
I’m going to speak with people he mentioned working with to see if he does this regularly, or if some circumstances came up that made him unable to make the investment. If the second, transfer the IP and create a new shell company. If the first, repurpose the business slightly and move it offshore.
jmpman
Close the company? If he’s not working in good faith, why should you? Of course consult a lawyer before you go that route.
vjust
He offered you money. There was no clause in your contract about the deadline for the delivery of the money? And the investor had put in weird clauses in there..

That makes you less than smart, and that makes the investor closer to a mafia - and these two parties make a deal!!

jiveturkey
WOW. Why on $DEITY's good earth would you give away 50% of your company to a seed investor. Let's assume the money comes in. You'll still be unable to raise a future round. You say you've worked in VC before?

You're done, wrap it up. Lesson learned. (and thanks for sharing)

digitaltrees
As others have said, if the investor didn’t perform his obligations under the contract, he is in breach of the agreement, and you can argue that shares were never validly conveyed to him. Get a lawyer, have them review the documents and send a letter demanding the money or the contact will be terminated.
akhsjdasjhd
I question whether or not you have actual, valid VC/PE experience if you signed over 50% of your company (at seed stage, with other investors potentially available) without having that equity actually paid for.

Sorry for the tough situation, but this is your fault; the investor didn't destroy your company - you did.

_tmel
I take fault for letting a bad actor in, which is why I’m sharing my case with everyone.
quickthrower2
Keep toughing it out, hope you get this fixed somehow in your favour. It’s not easy sharing something like this and admitting you made a mistake. The good thing is you won’t make it again.
akhsjdasjhd
Understood, but you shouldn't blame the Investor - you failed to do proper due diligence and also accepted poor terms when there were multiple, other investors potentially willing to fund the company. You shouldn't blame the Investor
ozten
Anything posted here is suitable during discovery. The risk/reward of posting on HN... doesn't seem worth it.
countryqt30
Just tell the investor: give us the money within the next 5 days or you are out. you broke the contract, so I can kick you out easily and undo it. you back own 100% of the company and can continue with a serious investor.