Should You Take Toxic Money?

Today we’re talking about nasty terms: what to do when you just might have to accept an ugly deal.

Because behind the scenes, my founders are telling me that the toxic termsheets are out in force.

A deal with “bad money” can start the death spiral.

But with a bit of being smarts, you just might get through it.

But here’s the reality in a tough-ish economy:

Sometimes money isn’t that easy to come by, and it comes with ugly strings attached.

Rule #1: Don’t do anything illegal, or accept money from illicit sources. We don’t want you on the cover of Forbes.

Aside from mafia money, there’s a ton of ways you can get caught out from liquidation prefs to nasty ratchets.

Sometimes you feel like you don’t have much of a choice, and gotta take the money when it’s in front of you.

But before you take an offer that feels “off”, here’s your playbook:

Step 1: Game out the offer

“I didn’t realize that was gonna happen” is no excuse for doing a bad deal.

Make sure you understand key terms. You especially want to focus on:

• Equity Dilution: How much ownership you’re giving away. Will it stop future investors from investing?
• Liquidation Preferences: Understand what happens during a liquidation event, and who gets what. Example: you might get $0 unless the company sells for at least $50 million
• Control Terms: Board seats, voting rights and veto powers can impact your decisionmaking & ability to run the company
• Exit Clauses: Any conditions where investors can force a sale or exit?

I cover toxic terms in more detail here.

But always get good legal and financial advice, even if you feel like you can’t afford it - because you definitely can’t afford to do a bad deal.

Step 2: Develop a plan

Get other offers ASAP.

Before going forward on tough terms, work overtime to find alternatives.

Check out my list of non-dilutive funding sources as a starter, but go beyond that - go back to other investors you might have previously written off.

I’ve worked with founders who thought they only had one option…

Once they had an offer on the table, they hit the drawing board again & circled the wagons.

Lo and behold, an alternative offer combination (in their case, equity plus a bit of debt) materialized.

Package B wasn’t great, but it was a LOT better than giving away 50% of their company.

You’d be surprised what you can accomplish once you’ve got an offer - EVEN IF it’s bad.

Step 3: Negotiate (and try to get a trapdoor)

No matter what, you should always do your best to negotiate.

Try to get the toxic terms taken out.

Try to get it watered down, neutralized or eliminated entirely.

But if you can’t manage that, then you might just have someone who is returns-motivated.

And in that case, try to work in a trapdoor.

Basically, a trapdoor is your way to get that investor OUT of the business ASAP.

There’s tons of ways to make this happen, but most will come in the form of a defined share-repurchase option.

Essentially, when you accept investment, at the same time you / the company has an option to repurchase the shares you’re issuing at a set price for a set period of time.

E.g. 150% up to 1 year, 200% up to 2 years…

So even if you’re forced to take on ugly terms, at least you have a way out.

Get a lawyer to paper it.

But always remember:

It comes down to you.

You’re the one in charge, and you don’t always have to take a bad deal.

There are alternatives (as unpalatable as they may be, they DO exist).

But if you do accept an “unpleasant” deal, then brace for stress.

Because it will have an impact on company culture for some time.

Just put your head down and grind.