Ask HN: Danger of raising money for a consumer web startup
We've quite randomly encountered a team of would-be startup incubator / money finders / placeholder executives who after meeting somewhat briefly with us and looking over our (slightly informative) business plan and partially functioning demo site, suggested that we re-form as an S Corp in Delaware, which would be preferable to our current LLC in California. They then sent over an offer to pay them $7k (half up-front) for the preparation of an investment kit (incorporation, business plan, stock purchase agreement, etc.), and mentioned a 4% commission on money raised and 4-7% founders' share equity for them with a ~$3M series A open-ended round, and that we would be able to keep majority share for the founders at that valuation.
Now, given the fact that we would apparently be their first clients, this is the point where most sane people would run away screaming. We declined their generous offer for the investment kit preparation as too risky for us given their lack of track record, but they would like to meet for more in-depth discussion and possibly some other kind of arrangement.
It's probably unrealistic for us to think about a series A round before we have content licensed, let alone users and revenue. That said, what do you think about involving people like this in a startup? Are there any red lines that we shouldn't cross here, for fear of making us unattractive to investors? What are some ways of minimizing our risk as we seek partners in raising money? Are there any particular resources you might suggest for us?
8 comments
[ 3.8 ms ] story [ 27.8 ms ] thread"They then sent over an offer to pay them $7k (half up-front) for the preparation of an investment kit (incorporation, business plan, stock purchase agreement, etc.), and mentioned a 4% commission on money raised and 4-7% founders' share equity for them with a ~$3M series A open-ended round, and that we would be able to keep majority share for the founders at that valuation."
I don't know an investor that would be happy paying 4% management fees to a middle man, or one who would want to work through a middle man instead of directly with the team tasked with executing.
Perhaps I'm misunderstanding how you're presenting this. But if I am understanding correctly this sounds like a very bad situation to get mixed up in.
Don't walk away, run away.
Don't let things like distract you. What matters here is building someone people and will pay for. Focus on that. Not about things like valuation, investment kits, and management fees (eww)
Note to Hisoka: looks like you've been ninja banned.
You pay cash (of which you are short) in exchange for some documents prepared by someone with no track record who you "randomly encountered."
In particular, for a startup (of the type YC tries to create) an S-corp is a lousy idea because they have only one class of stock and are precluded from taking investment from many types of corporate entities.
On the scam side, they're looking at $127,000 in fees plus at least that much in equity. Anyone who has an interest in the long term growth of a startup is doing everything they can to keep cash available for development, not shorten the runway.
You're being distracted by something that isn't likely to put dollars in your pocket.
Good Luck.
My bad. Should have known it was at least twice as much in equity since the proposal was that the founders would keep a majority of the shares.
$3 million input is less than half the value. Ergo, a minimum of $6 million + valuation (without considering an option pool) means that 4% equity has a face value of at least $240,000.
Also, I am not certain that an S-corp allows for an 83(b) election in regards to stock options (talk to an accountant) and make shareholders (e.g. founders) responsible for tax upon the increase in the value of their stock. It could result in a huge personal tax bill for the tax year in which funding occurred. Again, talk to an accountant.