Imagine that you are just getting settled at your startup and decide a little extra capital could help your startup set the world on fire. So you approach your friends and family about investing in your startup company. Everyone turns you down, except for your Uncle Steve who can’t wait to invest in the next Facebook.
But little did you know that Uncle Steve subscribes via RSS to VentureBlog and follows Brad Feld’s tweets. Thus, Uncle Steve doesn’t want mere common stock but rather desires to be issued preferred stock. You were prepared to issue preferred stock to venture capitalists, but what do you do with Uncle Steve?
Issue Uncle Steve a diluted ‘Series A’ preferred shares. While you can oblige Uncle Steve’s risk tolerance through various economic, control, liquidity, and management terms with the preferred stock, the most important thing to do is maintain the ability to raise future venture funds. Limit shareholder rights (tag-along), keep a basic liquidation preference, think about a drag-along provision, etc. It’s OK to let Uncle Steve get some preferred provisions, but it can’t become an obstacle to future financings.