What should I consider before using company stock in exchange for an investment?
One thing that most businesses have problems with or issues with at the beginning is money, is funding. I have worked with entrepreneurs that have come up with great business ideas and put together what appeared to me to be very sound business plans, only to have them run short of money. Typically, that is the most widely sought after and most misunderstood things about starting a new business.
What most people do is, they say I will be more than happy to give you 10% of my stock in exchange for $250,000. What they don’t know is the person that’s loaning them that money is really buying 10% of the company. They’re not going to be deluded, and by that I mean is if you decide that you’re going to issue twice as much stock in the future, their ownership interest in the company is going to require you to basically double the amount of stock that they have.
What I recommend that you do is consider things like loans with the opportunity for the investor to convert to stock at a very low price, sometimes a dollar a share, and then that would only occur when the business goes public. They have a loan, they get an interest rate, they are repaid that way. They’re happy because, in terms of liquidation, someone who has a loan or a note with a company has a higher priority than someone who has stock in the company. They also, if the company’s successful, can have more than a home run with the investment of their money. The most expensive way that you can get money for your business is to issue stock. I strongly recommend that you avoid it if at all possible.