How to sell shares in a small, privately held startup

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Nyarlathotep
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How to sell shares in a small, privately held startup

Post by Nyarlathotep »

I put some cash into my brother-in-law's startup business about six years ago in return for a small equity stake. The business is still around, has gone through a larger round of seed funding, and both revenues and customers have grown somewhat, but I'm starting to feel like I'd rather just sell my shares and lock in the (small) gains than wait for a bigger payoff if/when there is a merger or acquisition.

My question is, what options do I have for selling my shares? There is no public market for them, obviously, and I'm not sure my BIL (the founder) would agree to buy them back right now, given the company's somewhat limited financials. What's the best approach for me to take to unload these shares at a fair valuation? I believe there may be another small round of equity funding on the horizon for this company, which would slightly dilute my percentage stake. If this happens, could I request (or insist) that my shares be included in this funding round, thus helping the other shareholders by reducing their dilution?

Any and all advice and ideas, especially from those with direct knowledge or experience with these sorts of things, would be greatly appreciated.
SouthernFIRE
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Re: How to sell shares in a small, privately held startup

Post by SouthernFIRE »

You've touched on the options for disposing of illiquid shares in small closely-held company. Best bet is to negotiate the purchase of your shares by one of the other current shareholders. If the company's prospects going forward are reasonable, you should be able to find a buyer although they will likely insist on a sufficient discount to make it worth their while. Your idea about requesting that your shares be purchased during the next fundraising is also reasonable and happens regularly; however, there is likely no basis for you to insist on a buyout.
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AlabamaPaul
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Re: How to sell shares in a small, privately held startup

Post by AlabamaPaul »

It should have been explained when you originally invested that there was no market for those securities. Did you not receive a prospectus?
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illumination
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Re: How to sell shares in a small, privately held startup

Post by illumination »

I'd go to the BIL first and ask him, just so it doesn't ruffle any feathers (even if you think he doesn't want to buy you out) then go out from there with existing investors.
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Nyarlathotep
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Re: How to sell shares in a small, privately held startup

Post by Nyarlathotep »

SouthernFIRE wrote: Mon Aug 17, 2020 3:11 pm You've touched on the options for disposing of illiquid shares in small closely-held company. Best bet is to negotiate the purchase of your shares by one of the other current shareholders. If the company's prospects going forward are reasonable, you should be able to find a buyer although they will likely insist on a sufficient discount to make it worth their while. Your idea about requesting that your shares be purchased during the next fundraising is also reasonable and happens regularly; however, there is likely no basis for you to insist on a buyout.
Thanks. This is pretty much what I've been thinking my options were. I had heard that, as a shareholder of record, I could insist (or at least insist on a vote by all shareholders) that my shares be offered up for inclusion in any future dilutive(?) funding round. Seems like this would be unanimously favored by other shareholders. If that's true, how would I go about this? Would I need to attend an upcoming board meeting and bring it up for discussion? Or would it be better just to talk to my BIL about it?
stan1
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Re: How to sell shares in a small, privately held startup

Post by stan1 »

Go talk to your brother in law.

Do you care about the future family relationship?
That might impact how hard you want to press this issue.
SouthernFIRE
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Re: How to sell shares in a small, privately held startup

Post by SouthernFIRE »

Nyarlathotep wrote: Mon Aug 17, 2020 3:32 pm
SouthernFIRE wrote: Mon Aug 17, 2020 3:11 pm You've touched on the options for disposing of illiquid shares in small closely-held company. Best bet is to negotiate the purchase of your shares by one of the other current shareholders. If the company's prospects going forward are reasonable, you should be able to find a buyer although they will likely insist on a sufficient discount to make it worth their while. Your idea about requesting that your shares be purchased during the next fundraising is also reasonable and happens regularly; however, there is likely no basis for you to insist on a buyout.
Thanks. This is pretty much what I've been thinking my options were. I had heard that, as a shareholder of record, I could insist (or at least insist on a vote by all shareholders) that my shares be offered up for inclusion in any future dilutive(?) funding round. Seems like this would be unanimously favored by other shareholders. If that's true, how would I go about this? Would I need to attend an upcoming board meeting and bring it up for discussion? Or would it be better just to talk to my BIL about it?
This is not a standard term but it is possible there is some unique provision in the company's governing documents. I would talk to BIL to confirm this is truly an option and what his thoughts are. As CEO, he is better positioned to get you a buyout if you can get him on board.
MotoTrojan
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Re: How to sell shares in a small, privately held startup

Post by MotoTrojan »

Nyarlathotep wrote: Mon Aug 17, 2020 3:32 pm
SouthernFIRE wrote: Mon Aug 17, 2020 3:11 pm You've touched on the options for disposing of illiquid shares in small closely-held company. Best bet is to negotiate the purchase of your shares by one of the other current shareholders. If the company's prospects going forward are reasonable, you should be able to find a buyer although they will likely insist on a sufficient discount to make it worth their while. Your idea about requesting that your shares be purchased during the next fundraising is also reasonable and happens regularly; however, there is likely no basis for you to insist on a buyout.
Thanks. This is pretty much what I've been thinking my options were. I had heard that, as a shareholder of record, I could insist (or at least insist on a vote by all shareholders) that my shares be offered up for inclusion in any future dilutive(?) funding round. Seems like this would be unanimously favored by other shareholders. If that's true, how would I go about this? Would I need to attend an upcoming board meeting and bring it up for discussion? Or would it be better just to talk to my BIL about it?
Not sure why you think this would be unanimously favored. There isn't infinite capital out there to be raised and every dollar that goes to you is a dollar that the company doesn't raise for future growth.
Boglegrappler
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Re: How to sell shares in a small, privately held startup

Post by Boglegrappler »

Do you care about the future family relationship?
That might impact how hard you want to press this issue
I've seen a couple of instances of minority shareholders wanting out. One was a former undersecretary of the Navy who helped a shipyard compete for some contracts, and took a couple percent of the company as his fee. He got old, and the CEO majority shareholder was completely preoccupied with running the business, and annoyed by the distraction of his friend wanting to sell. As far as I know he never got his money out.

The other was a situation where a family whose mother had made a small investment to help her nephew get started in an industrial services firm watched the company grow over the years, and finally decided they wanted the company to buy them out. That deal got done for a low seven figure amout, but it happened just before a big turn in the markets and the company went public about a year after they agreed on their price. The valuation was about double (and the company has prospered since).

I would proceed very gently, for lack of a better term. It's a general truth that the guys running the enterprise don't like to be bothered with investors who want out. They're concerned with other things. You brother also has the issue that if he uses some of the next financing proceeds to take you out, it might well trigger a request from others to be taken out pro rata. That might not be a discussion he wants to have at any given moment.

He might be able to buy you out with his own money (not the company's),if he's liquid enough, but even then he has a disclosure obligation, I believe to the other investors. Lots of stuff to consider. Tread softly.
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Nyarlathotep
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Re: How to sell shares in a small, privately held startup

Post by Nyarlathotep »

MotoTrojan wrote: Mon Aug 17, 2020 3:45 pm Not sure why you think this would be unanimously favored. There isn't infinite capital out there to be raised and every dollar that goes to you is a dollar that the company doesn't raise for future growth.
Hmm, true. I guess I was assuming that other shareholders would prefer not to be diluted as much, and by including my shares in the financing round the dilution for others would be reduced. But you're correct that the downside would be that less cash would be injected into the business for operations, growth, etc. Thanks for that perspective.
oldfort
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Re: How to sell shares in a small, privately held startup

Post by oldfort »

Sell to someone else who is already invested in the company. Otherwise, you might run into issues like whether someone is an accredited investor.
000
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Re: How to sell shares in a small, privately held startup

Post by 000 »

oldfort wrote: Mon Aug 17, 2020 4:59 pm Sell to someone else who is already invested in the company. Otherwise, you might run into issues like whether someone is an accredited investor.
Is OP actually required to check that? Do you have a cite?
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AlabamaPaul
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Re: How to sell shares in a small, privately held startup

Post by AlabamaPaul »

Nyarlathotep wrote: Mon Aug 17, 2020 4:56 pm
MotoTrojan wrote: Mon Aug 17, 2020 3:45 pm Not sure why you think this would be unanimously favored. There isn't infinite capital out there to be raised and every dollar that goes to you is a dollar that the company doesn't raise for future growth.
Hmm, true. I guess I was assuming that other shareholders would prefer not to be diluted as much, and by including my shares in the financing round the dilution for others would be reduced. But you're correct that the downside would be that less cash would be injected into the business for operations, growth, etc. Thanks for that perspective.
New investors will not be concerned about diluting your shares, only their investment...
usedtoplayrugby
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Re: How to sell shares in a small, privately held startup

Post by usedtoplayrugby »

Have you looked at markets for private shares like EquityZen, Forge, Sharespost, etc? Those exist to provide liquidity in private markets though the company typically has to be large / well-known enough to generate interest from potential buyers.

Otherwise, echo the advice that you should speak to the company management regarding selling your shares as part of a future fundraising event. It does create more headache / complexity for management, but it also has benefits where it provides a way to give greater ownership to the new investors (if this is what they want). Sometimes, in a really hot company there can be an issue where investors in the prior round have pro-rata rights to prevent dilution and this can crowd out new investors who want more ownership, so having current investors (like yourself) sell their shares can free up space on the cap table.
oldfort
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Re: How to sell shares in a small, privately held startup

Post by oldfort »

000 wrote: Mon Aug 17, 2020 5:01 pm
oldfort wrote: Mon Aug 17, 2020 4:59 pm Sell to someone else who is already invested in the company. Otherwise, you might run into issues like whether someone is an accredited investor.
Is OP actually required to check that? Do you have a cite?
Here's an overview of the SEC on exempt offerings. If the OP read the operating agreement, it wouldn't surprise me if there were restrictions on his ability to sell: such as a right to first refusal.
https://www.sec.gov/smallbusiness/exemp ... ringschart
Topic Author
Nyarlathotep
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Re: How to sell shares in a small, privately held startup

Post by Nyarlathotep »

Boglegrappler wrote: Mon Aug 17, 2020 3:58 pmI would proceed very gently, for lack of a better term. It's a general truth that the guys running the enterprise don't like to be bothered with investors who want out. They're concerned with other things. You brother also has the issue that if he uses some of the next financing proceeds to take you out, it might well trigger a request from others to be taken out pro rata. That might not be a discussion he wants to have at any given moment.

He might be able to buy you out with his own money (not the company's),if he's liquid enough, but even then he has a disclosure obligation, I believe to the other investors. Lots of stuff to consider. Tread softly.
All good advice, thanks. I'm pretty sure my BIL would not offer to buy my shares with his own money, since he already owns a large chunk of the company. But I know he'll be somewhat sympathetic to my request and would make reasonable efforts to help me out. Given that we've had some personal issues/static in the past, however, I doubt he'll go to great lengths to ensure I get the best possible valuation. Ahh, the joys of friend-and-family "angel" investing.
stan1 wrote: Mon Aug 17, 2020 3:38 pmDo you care about the future family relationship?
That might impact how hard you want to press this issue.
Absolutely, I do care about my relationship with the family. But I also really want to sell my shares. I'd be willing to risk some minor interpersonal/family unpleasantness in exchange for getting my money back at a decent valuation.
inbox788
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Re: How to sell shares in a small, privately held startup

Post by inbox788 »

Nyarlathotep wrote: Mon Aug 17, 2020 3:02 pmI put some cash into my brother-in-law's startup business about six years ago in return for a small equity stake.
What was your exit strategy? Is the company going IPO? How many shareholders? If it's a small family business, it might never go IPO, and you're stuck selling to shareholders (sometimes as few as one).

There used to be SecondMarket, but looks like they're been absorbed into NASDAQ. https://www.nasdaq.com/solutions/nasdaq-private-market
I was looking to see if InstaCart was listed there, but instead found another pre-IPO exchange. https://equityzen.com/
BestCoast123
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Re: How to sell shares in a small, privately held startup

Post by BestCoast123 »

You need to read the org. docs to see what's allowed. Note that they were most likely re-written after the last round of fundraising (the newest money gets to write the rules).

There's probably a restriction on transfers / ROFO / etc.

Now would likely not be a good time to be a seller for illiquid shares, even if you can. If it's allowed, if you can wait until the next round of funding to try and sell. At least there will be some demand and easier to justify price/value.

Unless you desperately need some liquidity, you're probably better off letting it ride at this point.

It's not uncommon to eventually see in the term sheet, where the investors might let the founders sell some of their existing shares (to buy a house or something), in those scenarios the investors usually have the option to sell a portion of their shares (pro rata) at that time.
000
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Re: How to sell shares in a small, privately held startup

Post by 000 »

BestCoast123 wrote: Mon Aug 17, 2020 5:37 pm You need to read the org. docs to see what's allowed. Note that they were most likely re-written after the last round of fundraising (the newest money gets to write the rules).
You can be retroactively deprived of your equity?
oldfort
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Re: How to sell shares in a small, privately held startup

Post by oldfort »

000 wrote: Mon Aug 17, 2020 5:42 pm
BestCoast123 wrote: Mon Aug 17, 2020 5:37 pm You need to read the org. docs to see what's allowed. Note that they were most likely re-written after the last round of fundraising (the newest money gets to write the rules).
You can be retroactively deprived of your equity?
Didn't something like this happen with FB in the Social Network, where Eduardo Saverin's shares were effectively diluted out of existence?
000
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Re: How to sell shares in a small, privately held startup

Post by 000 »

oldfort wrote: Mon Aug 17, 2020 5:45 pm
000 wrote: Mon Aug 17, 2020 5:42 pm
BestCoast123 wrote: Mon Aug 17, 2020 5:37 pm You need to read the org. docs to see what's allowed. Note that they were most likely re-written after the last round of fundraising (the newest money gets to write the rules).
You can be retroactively deprived of your equity?
Didn't something like this happen with FB in the Social Network, where Eduardo Saverin's shares were effectively diluted out of existence?
I've heard that too. Not sure about the truth of it all.

I was actually refer to being retroactively restricted from selling further than the restrictions in place when you bought. If true, I would like to know.
inbox788
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Re: How to sell shares in a small, privately held startup

Post by inbox788 »

000 wrote: Mon Aug 17, 2020 5:48 pm
oldfort wrote: Mon Aug 17, 2020 5:45 pm
000 wrote: Mon Aug 17, 2020 5:42 pm
BestCoast123 wrote: Mon Aug 17, 2020 5:37 pm You need to read the org. docs to see what's allowed. Note that they were most likely re-written after the last round of fundraising (the newest money gets to write the rules).
You can be retroactively deprived of your equity?
Didn't something like this happen with FB in the Social Network, where Eduardo Saverin's shares were effectively diluted out of existence?
I've heard that too. Not sure about the truth of it all.

I was actually refer to being retroactively restricted from selling further than the restrictions in place when you bought. If true, I would like to know.
OT, but OP should get so lucky. If I followed correctly, he was diluted from 30% founder to 10%, so he lost $20B or gained $10B depending on whether the glass is half empty or half full.
But also like the Winklevosses, Saverin won huge in the end. Thanks to Zuckerberg and the rest of the Facebook team, most of Saverin's $10 billion wealth still comes from his little $15,000 investment, with no further effort from himself.
https://www.businessinsider.com/how-mar ... any-2012-5
kiwi123
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Re: How to sell shares in a small, privately held startup

Post by kiwi123 »

Talk to BIL. Make it as easy as possible for him as he is sure to have more urgent things on his plate. For example, can you wait to the next likely fundraising event and/or capital influx. If you can, then the lawyers can take care of it at the same time as the new shareholders investing. And he may have someone that he knows that would be willing to purchase your equity.

For fair market value, if there was a recent round then you "could" feel safe that that would be the FMV assuming nothing negative has happened since then. Or, if you wait to the next financing event then that would be the FMV.

Just also want to mention that you should feel incredibly lucky to (i) have not lost your money/investment, (ii) that you might come out ahead, and (iii) that your BIL has probably been working his @ss off to make sure #1 and #2 happened :-)
Makaveli
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Re: How to sell shares in a small, privately held startup

Post by Makaveli »

Following. My brother is beginning his own sales company and I am considering investing in his venture for 10-15% of the company.
oldfort
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Re: How to sell shares in a small, privately held startup

Post by oldfort »

inbox788 wrote: Mon Aug 17, 2020 7:56 pm
000 wrote: Mon Aug 17, 2020 5:48 pm
oldfort wrote: Mon Aug 17, 2020 5:45 pm
000 wrote: Mon Aug 17, 2020 5:42 pm
BestCoast123 wrote: Mon Aug 17, 2020 5:37 pm You need to read the org. docs to see what's allowed. Note that they were most likely re-written after the last round of fundraising (the newest money gets to write the rules).
You can be retroactively deprived of your equity?
Didn't something like this happen with FB in the Social Network, where Eduardo Saverin's shares were effectively diluted out of existence?
I've heard that too. Not sure about the truth of it all.

I was actually refer to being retroactively restricted from selling further than the restrictions in place when you bought. If true, I would like to know.
OT, but OP should get so lucky. If I followed correctly, he was diluted from 30% founder to 10%, so he lost $20B or gained $10B depending on whether the glass is half empty or half full.
But also like the Winklevosses, Saverin won huge in the end. Thanks to Zuckerberg and the rest of the Facebook team, most of Saverin's $10 billion wealth still comes from his little $15,000 investment, with no further effort from himself.
https://www.businessinsider.com/how-mar ... any-2012-5
At least in the movie, Saverin is diluted to 0.03% at one point. After years of litigation, he does eventually reach a settlement of 5% of the company.
BestCoast123
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Re: How to sell shares in a small, privately held startup

Post by BestCoast123 »

000 wrote: Mon Aug 17, 2020 5:42 pm You can be retroactively deprived of your equity?
No. Need to read the OA to see what kind of transfers, if any, are allowed.

As someone else mentioned, right now everything (should be) structured for growth. Also, not a good sign to other onvestors if founder's brother or BIL wants to bail.
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Nyarlathotep
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Re: How to sell shares in a small, privately held startup

Post by Nyarlathotep »

kiwi123 wrote: Mon Aug 17, 2020 9:56 pmJust also want to mention that you should feel incredibly lucky to (i) have not lost your money/investment, (ii) that you might come out ahead, and (iii) that your BIL has probably been working his @ss off to make sure #1 and #2 happened :-)
I do feel pretty lucky, actually. I knew perfectly well going in that my investment might never pay off, so if it does end up giving me a small return, I'll be happy. FWIW, if I'd put the entire amount into an S&P 500 fund six years ago, I would have more than doubled my money by now. Lesson learned, I guess.
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Nyarlathotep
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Re: How to sell shares in a small, privately held startup

Post by Nyarlathotep »

Makaveli wrote: Mon Aug 17, 2020 10:20 pmFollowing. My brother is beginning his own sales company and I am considering investing in his venture for 10-15% of the company.
I would advise against it. I've learned the hard way that you rarely get even remotely close to the same ROI from a "friends and family" investment as you do from sticking your money into a good, low cost, diversified ETF. In addition, investing in a friend or family member's business almost always, eventually, adds some level of friction, awkwardness, and discord to the relationship. Why risk souring a good relationship for something that's most likely never going to match what you could get from a garden-variety index fund?
LFS1234
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Re: How to sell shares in a small, privately held startup

Post by LFS1234 »

Makaveli wrote: Mon Aug 17, 2020 10:20 pmFollowing. My brother is beginning his own sales company and I am considering investing in his venture for 10-15% of the company.
Nyarlathotep wrote: Tue Aug 18, 2020 11:38 am I would advise against it. I've learned the hard way that you rarely get even remotely close to the same ROI from a "friends and family" investment as you do from sticking your money into a good, low cost, diversified ETF. In addition, investing in a friend or family member's business almost always, eventually, adds some level of friction, awkwardness, and discord to the relationship. Why risk souring a good relationship for something that's most likely never going to match what you could get from a garden-variety index fund?
It depends. You have to go into it understanding that there is a big likelihood of losing your entire investment, you have to actually be prepared to lose your entire investment, and if things do go south, you cannot blame anybody but yourself for the loss. You can't let it negatively affect your relationships, no matter what happens.

If you can do all that, and you can blame yourself even if the fault quite clearly seems to lie with your partners, and the investment opportunity is affordable and looks attractive, then by all means consider proceeding.

I have over the years been involved in about a dozen closely held businesses, and have had to find a way out of several of them. Many of them have not been particularly lucrative. Some have been fine. One has been extraordinary. Nowadays, I'm extremely picky about who I get involved with, I'm the one who has the shareholder agreements drawn up, and I make sure that I retain some leverage even when I'm a minority shareholder. I enjoy being involved in productive businesses with people whom I like, respect and trust.
Makaveli
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Re: How to sell shares in a small, privately held startup

Post by Makaveli »

LFS1234 wrote: Tue Aug 18, 2020 12:16 pm
Makaveli wrote: Mon Aug 17, 2020 10:20 pmFollowing. My brother is beginning his own sales company and I am considering investing in his venture for 10-15% of the company.
Nyarlathotep wrote: Tue Aug 18, 2020 11:38 am I would advise against it. I've learned the hard way that you rarely get even remotely close to the same ROI from a "friends and family" investment as you do from sticking your money into a good, low cost, diversified ETF. In addition, investing in a friend or family member's business almost always, eventually, adds some level of friction, awkwardness, and discord to the relationship. Why risk souring a good relationship for something that's most likely never going to match what you could get from a garden-variety index fund?
It depends. You have to go into it understanding that there is a big likelihood of losing your entire investment, you have to actually be prepared to lose your entire investment, and if things do go south, you cannot blame anybody but yourself for the loss. You can't let it negatively affect your relationships, no matter what happens.

If you can do all that, and you can blame yourself even if the fault quite clearly seems to lie with your partners, and the investment opportunity is affordable and looks attractive, then by all means consider proceeding.

I have over the years been involved in about a dozen closely held businesses, and have had to find a way out of several of them. Many of them have not been particularly lucrative. Some have been fine. One has been extraordinary. Nowadays, I'm extremely picky about who I get involved with, I'm the one who has the shareholder agreements drawn up, and I make sure that I retain some leverage even when I'm a minority shareholder. I enjoy being involved in productive businesses with people whom I like, respect and trust.
Both have valid points, thanks for the perspectives.
kiwi123
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Re: How to sell shares in a small, privately held startup

Post by kiwi123 »

Makaveli wrote: Tue Aug 18, 2020 6:00 pm
LFS1234 wrote: Tue Aug 18, 2020 12:16 pm
Makaveli wrote: Mon Aug 17, 2020 10:20 pmFollowing. My brother is beginning his own sales company and I am considering investing in his venture for 10-15% of the company.
Nyarlathotep wrote: Tue Aug 18, 2020 11:38 am I would advise against it. I've learned the hard way that you rarely get even remotely close to the same ROI from a "friends and family" investment as you do from sticking your money into a good, low cost, diversified ETF. In addition, investing in a friend or family member's business almost always, eventually, adds some level of friction, awkwardness, and discord to the relationship. Why risk souring a good relationship for something that's most likely never going to match what you could get from a garden-variety index fund?
It depends. You have to go into it understanding that there is a big likelihood of losing your entire investment, you have to actually be prepared to lose your entire investment, and if things do go south, you cannot blame anybody but yourself for the loss. You can't let it negatively affect your relationships, no matter what happens.

If you can do all that, and you can blame yourself even if the fault quite clearly seems to lie with your partners, and the investment opportunity is affordable and looks attractive, then by all means consider proceeding.

I have over the years been involved in about a dozen closely held businesses, and have had to find a way out of several of them. Many of them have not been particularly lucrative. Some have been fine. One has been extraordinary. Nowadays, I'm extremely picky about who I get involved with, I'm the one who has the shareholder agreements drawn up, and I make sure that I retain some leverage even when I'm a minority shareholder. I enjoy being involved in productive businesses with people whom I like, respect and trust.
Both have valid points, thanks for the perspectives.
LFS1234: This is so true... a good summary and mirrors my personal experiences. A few poor experiences but 1 very fortunate experience. And the people aspect is so important. If you have any concerns or doubts about the people involved, or how you'll react if things go poorly, then might be better to step away.

Makaveli: Go in fully aware of the worst case = losing it all and not blaming anyone else but yourself. Also make sure you have no liability in case of a BK or significant business liability/issue. Guessing a sales company that you can invest for 10% of the company is an operation that doesn't require much overhead to get started. Make sure you don't skimp on proper legal advice when reviewing the business and operating agreement.
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