This post originally appeared on Charlotte Agenda.
Norm (noun): something that is usual or expected
There are norms throughout our society. Individuals are free to ignore those norms, but run the risk of being rejected for not behaving in the expected manner. When interviewing for a job one doesn’t have to follow up with a thank you note to the interviewer, but not doing will reduce the chances of being offered the position.
There are norms that apply to the business world as well. I could insist that all of my clients at Cardinal Finance pay up front for a full year’s worth of service, with the likely result being that most if not all of them would politely decline and find another service provider.
The world of startup financing has its norms as well. A company is free to ignore those norms, but should not be surprised if it encounters resistance and ultimately has a difficult time raising capital. When a startup approaches a potential investor with an unconventional corporate or investment structure it is not likely to be well received.
Some of the norms that apply to the world of angel or venture capital funding for early stage companies are as follows:
Investors get their money back before founders benefit from a sale of the company. It should not be possible for the founders to win financially on a sale of the company while investors lose. There are many ways to structure it, but the principle is that if the company is sold for less than the total amount that investors have put into it all of the proceeds go to the investors.
Founders aren’t going to get paid market salaries until they can be paid from revenue rather than investor funds. Investors aren’t looking for founders to starve, but they don’t want to be the only ones taking financial risk in the venture. Founders who are seeking to raise early stage capital while talking about the need to pay themselves market wages can appear to be unwilling to appropriately share in the risk of a startup.
Big decisions will require some form of investor approval. If an investor is financing the business, it it not unreasonable for decisions beyond some threshold to directly or indirectly require investor approval. This can be structured as requiring explicit investor approval, or approval by a board of directors with the investor having representation on the board.
Raising capital is by no means an easy task. Startups should be very wary of complicating the matter by ignoring the norms in this area.