5 ms·

In principle this seems pretty cool, but the gap between what's communicated on the website, and what's actually contained in the 'Shared Earning Agreement' [1]

by laser 8y ago

In principle this seems pretty cool, but the gap between what's communicated on the website, and what's actually contained in the 'Shared Earning Agreement' [1] makes me concerned this might be good marketing on a fundamentally predatory investment agreement. This could very well be a completely unintentional idiosyncrasy, so I don't want to be too accusatory, but the implication of the terms needs to be laid out more clearly on the website, if this is simply an oversight. The single biggest red-flag is the fact that the equity stake vests in company sale or priced-raise as unpaid return cap (a multiple of 3-5X investment) over valuation cap. What this essentially means, is that in the scenario that you raise more money or sell the company before you've paid off the 3-5x multiple of the investment, then the investment essentially vests as if the valuation cap was 3-5x lower than what it was actually set at. This probably seems abstract, so I'll make it vividly clear with an example. Let's say you raise $200k on a $2 million valuation with a 5x return cap on an SEA. Business goes well, a year or two goes by, and you either sell the company or raise more capital at a $10 million valuation, having in the interim say paid off $200k of the agreement from earnings. With 4x still outstanding. Suddenly, likely to your surprise, that $800k (4x investment amount) vests into equity—at the $2 million cap from the original agreement. In other words, Earnest Capital suddenly, to your surprise, owns 40% of your company. If you hadn't monetized at all and paid any off, this could be a full 50% stake. Even if you run the numbers with the more conservative numbers in their document—is it clear to people that a $150k investment at a "$3 million" valuation could convert to a 15% equity stake in your company? I'd love to see how this could be revised to address this issue, and I'd love to see the website more clearly communicate the equity implications. As of now, I can't help but feel that this is double-dipping, predatory investing, that is getting heaps of praise on HN due to clever marketing around tapping into the trend of anti-VC and indie-hacking, that will ultimately lead to some very frustrating experiences for first-time entrepreneurs that didn't fully comprehend the terms they were agreeing to. Tyler—please prove me wrong and fix this thing. Or, since IANAL I may have completely misunderstood the document, in which case—screw me, my apologies—but please explain how it actually works :) [1] https://docs.google.com/document/d/1MoLiH_VnhX-0vfZ1zgMSfpcIt0rdyD9rc27BbypplDI/ https://docs.google.com/document/d/1MoLiH_VnhX-0vfZ1zgMSfpcI...

hotpockets 8y ago
Would it be legal for the startup to take a loan of $800k and just pay off the remaining balance? Then EC gets their 5x, and you keep your equity? (Probably the new investors would see the advantage of this)
- laser 8y ago
  IANAL, but it's ambiguous from my reading—leaning towards no, not without them accepting. The reason being that the reduction in the 'Return Cap' is through a quarterly pay-off-mechanism as a percentage of earnings, set out in the agreement. There may be case law or general legal precedent that requires them to take your money if you wish to pay them off, but a literal reading of the agreement in a vacuum doesn't suggest to me that they have to take your early payment. There is precedent for things like car loans or mortgages or w/e, where there's a penalty for paying off early (They want to keep milking you for interest). So, without an explicit provision I would assume you cannot pay off the return cap, except through the set percentage of earnings per quarter.
- tylertringas 8y ago
  It's relatively easy to write terms that (a) allow something like this to adversely affect us if done on good faith over the normal course of business and (b) prevent founders from doing this maliciously to engineer more equity in the event of a sale. Our final deal docs go into this.
nathan_f77 8y ago
Some comments below are talking about a 9.5% "residual stake". But I don't have a clear understanding of how it works, and would definitely appreciate some clarification before I apply. I'm strongly considering TinySeed, Indie.vc, and now Earnest Capital. It's hard to navigate all of these terms and weigh the pros and cons. At the moment I'm leaning towards TinySeed because of the mentorship and community in the accelerator program. It sounds like Earnest Capital is more "hands-off", but it also doesn't take any equity (unless you raise more money or sell the company.)
nathan_f77 8y ago
I just read through the terms in the SEA, and I think you're right about how it works out. I guess this is an "escape hatch" for companies that start off independent, but then change their mind and decide to pursue traditional VC funding. YC invests $150k for a 7% stake, with the expectation that you will raise 7 figures and aim for a billion dollar exit. You won't get accepted to YC unless you can convince them that you're aiming for a unicorn. = I think it might actually be fair to penalize a company if they say they are going to build a sustainable, profitable business, and then they change the rules by aiming for a unicorn. Earnest Capital would be taking on a lot of risk that they didn't ask for, because moonshots are extremely risky compared to a small profitable business that can grow at it's own pace. The founder gets to go for a moonshot and spend all of the money, and they'll likely go bankrupt because moonshots are extremely risky. And if they succeed, then Earnest Capital only gets a $450k return from a billion dollar company. A VC expects a 10x to 30x return for this kind of risk ($1.5M - $4.5M.) Also the return is capped at 3-5X, so I think these terms are pretty good for the founder. A business loan would be better, but it doesn't come with any mentorship or accelerator program, and I personally won't be able to get one because I live in Thailand (although I have a US company.) This would be give me a really good boost so that I can pay for a few big projects that I couldn't otherwise afford (redesign, increased marketing budget for ads and newsletters, audits and certifications, and a few features where I could hire some contractors.) TinySeed invests $120k in exchange for 8-15% equity. So that's like Earnest Capital + immediate Equity Conversion. The equivalent for Earnest Capital might be a $75k investment with a $3M valuation cap. (75000 * 3) / 3000000 = 7.5% equity if you sold or raised more money without paying anything back. 2.5% if you have less than $75k remaining, and 0% as soon as you reach the return cap. I think that cliff is a bit weird. Earnest Capital would have 2.5% equity even if you only had a single dollar remaining until you reach the Return Cap, then it immediately falls to 0%. I think it would be better if there was a gradual drop from 2.5% to 0% as your remaining payment amount goes from $75k - $0. If I apply, I might ask them to change this term. I would also like to know if it would be possible to buy back shares from the TinySeed investors. I didn't see anything about that. But for a small sustainable company, I'd honestly be happy to just pay myself a reasonable salary, and pay some dividends from time to time. 8% wouldn't be too bad. EDIT: Just thinking some more. It would take so long to pay back this Earnest Capital loan! If your company gets to $10k Founder Earnings per month, you'd be paying back $3k * 3 = $9k per quarter, or $36k per year. Even if you only took a $75k investment, it would take you 6.25 years to reach the $225k cap. It's sort of like golden handcuffs, where you can't sell or raise any more money without giving away significant equity (and you would be better off with the TinySeed deal.) On the other hand, if you can get to $10k by the first year, and $100k by the second or third year, then it would be repaid very quickly. ($360k per year). I think I'm leaning towards TinySeed. But it's hard to weigh all the pros and cons.

by laser 8y ago

hotpockets 8y ago

Would it be legal for the startup to take a loan of $800k and just pay off the remaining balance? Then EC gets their 5x, and you keep your equity? (Probably the new investors would see the advantage of this)

laser 8y ago
IANAL, but it's ambiguous from my reading—leaning towards no, not without them accepting. The reason being that the reduction in the 'Return Cap' is through a quarterly pay-off-mechanism as a percentage of earnings, set out in the agreement. There may be case law or general legal precedent that requires them to take your money if you wish to pay them off, but a literal reading of the agreement in a vacuum doesn't suggest to me that they have to take your early payment. There is precedent for things like car loans or mortgages or w/e, where there's a penalty for paying off early (They want to keep milking you for interest). So, without an explicit provision I would assume you cannot pay off the return cap, except through the set percentage of earnings per quarter.
tylertringas 8y ago
It's relatively easy to write terms that (a) allow something like this to adversely affect us if done on good faith over the normal course of business and (b) prevent founders from doing this maliciously to engineer more equity in the event of a sale. Our final deal docs go into this.

nathan_f77 8y ago

Some comments below are talking about a 9.5% "residual stake". But I don't have a clear understanding of how it works, and would definitely appreciate some clarification before I apply. I'm strongly considering TinySeed, Indie.vc, and now Earnest Capital. It's hard to navigate all of these terms and weigh the pros and cons. At the moment I'm leaning towards TinySeed because of the mentorship and community in the accelerator program. It sounds like Earnest Capital is more "hands-off", but it also doesn't take any equity (unless you raise more money or sell the company.)

nathan_f77 8y ago

I just read through the terms in the SEA, and I think you're right about how it works out. I guess this is an "escape hatch" for companies that start off independent, but then change their mind and decide to pursue traditional VC funding. YC invests $150k for a 7% stake, with the expectation that you will raise 7 figures and aim for a billion dollar exit. You won't get accepted to YC unless you can convince them that you're aiming for a unicorn. = I think it might actually be fair to penalize a company if they say they are going to build a sustainable, profitable business, and then they change the rules by aiming for a unicorn. Earnest Capital would be taking on a lot of risk that they didn't ask for, because moonshots are extremely risky compared to a small profitable business that can grow at it's own pace. The founder gets to go for a moonshot and spend all of the money, and they'll likely go bankrupt because moonshots are extremely risky. And if they succeed, then Earnest Capital only gets a $450k return from a billion dollar company. A VC expects a 10x to 30x return for this kind of risk ($1.5M - $4.5M.) Also the return is capped at 3-5X, so I think these terms are pretty good for the founder. A business loan would be better, but it doesn't come with any mentorship or accelerator program, and I personally won't be able to get one because I live in Thailand (although I have a US company.) This would be give me a really good boost so that I can pay for a few big projects that I couldn't otherwise afford (redesign, increased marketing budget for ads and newsletters, audits and certifications, and a few features where I could hire some contractors.) TinySeed invests $120k in exchange for 8-15% equity. So that's like Earnest Capital + immediate Equity Conversion. The equivalent for Earnest Capital might be a $75k investment with a $3M valuation cap. (75000 * 3) / 3000000 = 7.5% equity if you sold or raised more money without paying anything back. 2.5% if you have less than $75k remaining, and 0% as soon as you reach the return cap. I think that cliff is a bit weird. Earnest Capital would have 2.5% equity even if you only had a single dollar remaining until you reach the Return Cap, then it immediately falls to 0%. I think it would be better if there was a gradual drop from 2.5% to 0% as your remaining payment amount goes from $75k - $0. If I apply, I might ask them to change this term. I would also like to know if it would be possible to buy back shares from the TinySeed investors. I didn't see anything about that. But for a small sustainable company, I'd honestly be happy to just pay myself a reasonable salary, and pay some dividends from time to time. 8% wouldn't be too bad. EDIT: Just thinking some more. It would take so long to pay back this Earnest Capital loan! If your company gets to $10k Founder Earnings per month, you'd be paying back $3k * 3 = $9k per quarter, or $36k per year. Even if you only took a $75k investment, it would take you 6.25 years to reach the $225k cap. It's sort of like golden handcuffs, where you can't sell or raise any more money without giving away significant equity (and you would be better off with the TinySeed deal.) On the other hand, if you can get to $10k by the first year, and $100k by the second or third year, then it would be repaid very quickly. ($360k per year). I think I'm leaning towards TinySeed. But it's hard to weigh all the pros and cons.