I remember a Christmas when I was in grade school, and my mother told me that one of my gifts was “ten feet long”.
Turns out it was a basketball hoop. Nice, Mom.
Sometimes, are perception of what is true is far different that reality, and unfortunately that happens when a business fails. A founder simply can’t fulfill the vision that was presented to the investors- maybe because the founder’s perception of the market, customer needs, and competitors is not the true reality.
No one’s fault, Business is tough, and starting a business from scratch can be brutally hard. (It has been for me, anyway….am I the only one?)
So it’s fair to ask the question: What happens to the founder and the angel investors if a company fails?
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For starters, let’s be clear about some definitions:
- Angel investor: Angel investors provide funding to startup businesses- companies that may not be able to issue debt, obtain a traditional bank loan, or raise capital through other traditional means. They may provide one-time funding, or funding in stages- but they’re investing in new businesses that do not have a performance track record, and the investment carries a high level of risk.
- Capital: Every business needs capital to purchase assets and operate, and there are two basic ways to raise capital: stock and debt. If a company issues debt, the investor is a creditor, while equity investors are owners.
- Shareholder rights: Equity (stock) investors have several rights, including the right to vote on major company decisions. Shareholders may also received a dividend, if the company has sufficient earnings and the board of director declares a dividend. Angel investors may insist on specific percentage of ownership, income payouts and the right to participate closely in management decisions.
So, those are the basic terms you need to know.
If you’re recovering from a financial setback, this article may help.
Every angel investor- all investors, in fact- want an exit ramp. They want to know how they can take their original investment out of the business, and generate a reasonable rate of return on their investment.
If a company’s stock is traded publicly, the exit ramp is easy to find- sell the stock on an exchange when the price goes up. Exits, however, are tougher for private, startup firms. The ultimate goal may be to go public using an initial public offering (IPO), or sell the firm to a larger business in the same (or similar) industry.
The most critical thing to know: Any equity investment can go to a market price of zero.
When things go south
So what happens when the business fails? Who gets what- if there’s anything left to get?
The answer- like many things in life- is “it depends”.
- Nothing happens: If the founder followed the business plan as explained to the investors and communicated along the way, it’s possible that the investors simply accept their losses and move on. The value of the investment goes to zero. After all, angel investors aren’t trying to bat 1000- they simply want afew big winners to offset the sum total of business investments that fail. So, maybe nothing happens. It’s very possible that the same founder gets the same investors to fund a new venture that succeeds.
- Something happens: If the founder doesn’t do what he or she says they will do, investors may pursue legal action. Maybe the founder uses funding to start a successful product or service- but tries to profit without the investors knowing about it. Or, the founder wants to quit the venture and keep the same percentage of ownership.
Open and honest
Angel investors are looking for talented people to invest in- and they realize that it may take the talented founder multiple pivots/ failures to finally succeed. If you’re open and honest throughout the process, it’s likely that nothing will happen if the venture fails.
If you’re a founder, be open and honest with your investors. It’s just what Mom would say
Author: Cost Accounting for Dummies, Accounting All-In-One for Dummies, The CPA Exam for Dummies and 1,001 Accounting Questions for Dummies
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This post was originally posted on my Quora page. This post is for educational purposes only.
Image: Bullseye, Jeff Turner CC by 2.0