What to do When Dealing with Informal Investors

Raising funding from formal investors isn’t always an option for every startup.

Particularly for young or unproven entrepreneurs, informal investors can seem like much more attractive options. And these more informal options can certainly give your startup the boost it needs. But just because they’re informal investors doesn’t mean you should overlook some of the more formal parts of the investment process.

You need to protect yourself and your company. So when it comes to those informal investors, whether they’re angel investors or members of your extended family, it helps to set very specific terms.

Dianna Labrien recently wrote about setting terms with informal investors in a Tech.Co post. She cautioned entrepreneurs against automatically agreeing to give all investors pro-rata rights, or the right to maintain ownership through future investment rounds. This could lead to your startup having too many different investors involved.

While on the surface “having too many investors” doesn’t sound like a problem, it can mean lots of extra work for you. And all of that work means time spent away from actually growing your business. Labrien wrote:

“Having too many people involved means you’ll be spending your time on unproductive things instead of focusing on further development. If you are not careful enough, you may find yourself in an uncomfortable position, spending time on collecting signatures from your shareholders to make future financing decisions or implement new management decisions. Mainly, this happens when you’ve given these rights to your first investor and the follow-on investors happen to request them as well.”

Informal investors can be incredibly helpful, if not essential, when getting your business off the ground. But it is still your business. You need to control how you spend your time. And investors can have a big impact on that part of your operations. You have to find the right balance between attracting the right investors and giving them too many rights to your business.

Labrien’s post also includes a few more tips for dealing with informal investors, such as restricting the number of shares offered and avoiding limits placed on management compensation.

Piggy Bank Photo via Shutterstock