You started a new company. It exciting. In the beginning you self finance it. A little bit of savings. A great deal more in credit cards debt. But shortly thereafter you start to realize that your credit cards will not carry you far enough. You need help. And others ... if they only support your idea, they can profit from your success. So you decide to swallow your pride, put on your salesman's hat and try to raise money from family and friends. but where do you start?
You start with a Letter of Intent. an LOI is a one to 2 page non-binding agreement that highlights the main substantive elements of any investment. Yes. Most often this is non-binding. Meaning, no one has to sign it and no one has to adhere to it.
Now an LOI doesn’t have to be very complicated. It can be, but it doesn’t have to be. In early stage investments. Like Pre-Seed rounds or Family and Friends rounds. Its is important to keep things very simple. It will help you a great deal in later rounds if your early rounds are simple.
Your LOI can be a simple bullet point letter stating that you are raising $15,000 in $1,000 increments. That your company is valued at a total of $100,000 which means that you are selling up to 15% of your company. That all shares will be common stock. That you will be closing on May 1st subject to certain conditions like the drafting of all appropriate and necessary legal documents and providing all requested information to investors.
Alternatively, if your raising money using debt. Your LOI can state that you are borrowing $100,000 at $1,000 increments. That you’ll pay interest only for 5 years year at an 8% interest and afterwards you’ll pay it off in a single balloon payment. Again, this will be conditioned on the drafting of notes and the provision of all requested documentation’s. Many people think that an LOI is a waste of time. Why waste time on a non-binding letter, if we’re just going to negotiate an agreement later on?
Here are the five reasons why you should always negotiate a non-binding letter of intent before starting to negotiate any investment agreement.
ONE: Having LOI allows you to more easily sell your investment. It gives you something simple and clear to leave with prospective investors. It gives you a simple short document over which to negotiate. Something they can look at long after your meeting ended. Something they can focus on. Contemplate. Something they can show their advisors or attorneys. It allows you to sell your investment even when you’re not there to present it.
TWO: It helps you reduce legal fees. Drafting an investment agreement can be a complicated task requiring the expertise of an attorney. AN LOI helps you reduce fees. If you’ve already negotiated all substantive matters in your LOI, the attorney only has to focus on matching the agreement to your deal. He doesn’t have to spend his time and your money in negotiating the substance of the deal.
THREE: Legal documents, whether as equity investment agreements or notes, can get complicated. You’ll be surprised how often people have to look back at the LOI to understand the deal the documents actually describe. The simplicity of the LOI allows investors to focus on what is important in the legal documents. The deal is exactly as they planned it.
FOUR: If there are disagreements, those get ironed out ion the LOI. You want to spend as much time as possible in the LOI stage, ironing out the details. This is the easiest stage. Attorneys are often not involved. You’re cost of back and forth negotiation is minimal. No one committed to an investment so an argument is not personal. Things get a lot more complicated when it comes to negotiating the investment agreement. But its a lot easier if you’ve ironed out the very sentence of the investment first.
FIVE: You’re less likely to lose a deal if you’ve negotiated the LOI successfully. There are many issues that require negotiation during the contract stage. Warranties, Indemnifications and Confidentiality provisions can be tricky. Attorneys can spend a great deal of time looking over these provisions. But if the structure of the deal has already been agreed to, there is less likelihood that the deal will fall through. As long as people sign up to the basic structure of the deal, they are less likely to drop out because of a disagreement over a legal provision.
SO these are the top 5 reasons why every equity and debt round sound start with an LOI. Spend the time upfront negotiation the structure of the deal. Go back and forth with the document unit everyone is comfortable with the terms. When disagreements arise, go back to the LOI. The goal is to get both parties to sign the LOI. Yes … it is not binding. But getting an LOI negotiated and singed, is the first step to a successful financial raise.