Many business owners raise funding using the following strategy:
- Identify potential investors.
- Get meetings with potential investors.
- Pitch to potential investors.
- Provide lots of information to the potential investors so they can do due diligence.
- Receive a term sheet from investors who are interested.
- Say yes or no to the term sheet.
Has it ever occurred to you how silly this is? You put a ton of time and energy into courting investors and responding to their due-diligence requests without knowing, until the very end of the process, on what terms the investment will be made.
What if the terms are completely wrong for your business? At that point, you’ve already invested so much time that you may decide to accept the money and try to ignore the fact that you’ve just set yourself up for a lot of unpleasantness down the road.
No one is more knowledgeable about your business than you. You live and breathe your business and you have a vision of what the business will look like when it has reached its ideal size and level of impact. This vision is what should inform the terms on which you accept investment. If you accept terms that are dictated by an investor, you risk sacrificing your vision, goals, and values in the name of complying with whatever the legal documents dictate.
Sadly, there are many examples of business owners who learned this too late — founders of companies like Odwalla and Ben & Jerry’s who were pushed by investors whose goals they didn’t share to sell their companies to buyers they didn’t want to sell to.
One reason so many business owners raise funding on terms that don’t fit their goals, values, and vision is that venture capitalists and their attorneys have developed standardized investment terms that are used in all their deals. It’s much less work for investors and their lawyers to keep investing on the same terms over and over again. The same old term sheets get used (with minor tweaks) regardless of whether they’re really a good fit for the business being invested in.
Every business and business owner is unique — ideally, investment terms should be tailored to each situation. Unfortunately, most lawyers and finance professionals are unwilling or unable to be creative.
This situation leaves entrepreneurs with two equally unattractive options: raise money in a way that requires you to give up control and put your investors’ interests ahead of everything else, or don’t raise money.
Fortunately, there is a third option: set your own terms to reflect what you care about most, including
- how you want to treat your employees, community, and other stakeholders;
- what you want your day-to-day life to be like (for example, are you up for 80-hour work weeks and investors who dictate your decisions?);
- how you want your business to grow; and
- how you see yourself and your investors someday exiting from the business.
The truth is that you can be just as creative with the terms of your investments as you are with every other aspect of your business.
Businesses that are strongly committed to mission and want to avoid being pushed by their investors to “sell out” have been designing creative term sheets for decades. These businesses are attracting supportive investors who trust the business founders and inside stakeholders to design investment terms that have the greatest likelihood of
- allowing the business to fulfill its founding mission and values;
- supporting the well-being of all the business stakeholders (and not elevating the interests of investors above other stakeholders); and
- providing a relatively low-risk reasonable return to investors.
An Example: How Equal Exchange Sets its Own Terms
One of my favorite examples of a business that has been successfully raising capital on its own terms for decades is Equal Exchange, a for-profit worker-owned Fair Trade cooperative.
Equal Exchange offers nonvoting preferred stock to investors with a five-year minimum holding period and a target annual 5 percent dividend. If the company is ever sold, all net proceeds must be donated to a nonprofit Fair Trade organization. This ensures that the investors will not have an incentive to pressure the company to sell. Using this unusual model, Equal Exchange has raised almost $20 million dollars, has about 500 investors, and actually has to turn investors away because demand for the nonvoting preferred stock outstrips supply.
Who will invest if I set the terms?
Some investors will not invest in your business if you set the terms. In fact, when pitching to venture capitalists, entrepreneurs are often advised that if they bring a term sheet they risk getting kicked out. These investors insist upon setting the terms on which they invest.
I call these folks professional investors. These are wealthy individuals and organizations, sometimes investing their own money and sometimes investing on behalf of others. They come in many flavors: angel investors, venture capitalists, private equity funds, family offices, private foundations, wealth managers, and so on. These are the kinds of investors who pushed Ben & Jerry’s to sell to the highest bidder.
The good news is that the investors who don’t want you to set your own terms make up a tiny percentage of the total potential investors out there.
Just because you’re unwilling to accept investments that don’t allow you to set your own terms doesn’t mean that you cannot raise hundreds of thousands and even millions of dollars from investors. There are investors who will be happy to support you on your own terms and not push you to sacrifice your goals and values.
A majority of the US adult population is made up of investors. These are people who have investments in stocks, bonds, mutual funds, and so on: 60 percent of households have retirement investments, 44 percent of households invest in mutual funds, and 52 percent of Americans invest in the stock market. And, of course, many more have funds invested in depository accounts at banks. If we were to estimate conservatively that half of the adult population has investments, that would mean that there are more than 120 million investors in the United States. Of all of the investors in the United States, only about 0.3 percent are professional investors.
In my experience, the 99.7 percent of the investor population who are not professional investors are quite open-minded about investment terms and are willing, often even excited, to invest on creative terms that are designed to serve the company’s mission.
So, before you start raising money for your business, take some time to design an investment offering that creates the highest possible likelihood of alignment between your goals and values and those of your investors