Investing in startups attracts high profit potential, but also hides significant risks, especially legal ones. To ensure that your investment is not just a generous gift, it is essential to understand not only the business, but also the contracts, legal instruments and mechanisms that protect the investor. We will advise you on how to safely enter the world of startups and not lose control of your stake.
A startup is a young company that has the ambition to grow rapidly, often based on an innovative idea, technology or approach to solving a problem. It’s not every new coffee shop on the corner, but rather an app that wants to change the way you book a hairdresser or shop for groceries, for example. Examples include Czech startup Rohlik.cz, which has transformed online grocery shopping, or Productboard, a product development management tool that is now used by companies around the world.
Unlike a traditional business , a startup often starts with no profit, but with a big vision. And that’s what makes it a tempting but risky target for investors.
Investing in startups means you put your money into a company that is just starting out. Often before the company has stable sales or customers. You hope that if it succeeds, its value will increase dramatically and your stake will appreciate.
Startups go through several stages of raising money:
As an investor, you can join at any stage, but the earlier you get involved, the higher the risk and potential return. The investment can be made by going directly into the equity or through an instrument called a convertible note (a loan that converts into shares in the future).
Startups tend to be full of promise, but without legal certainty you risk everything. We can help you with due diligence, contracts and negotiating terms. Your share, your rules.
When it comes to startup investments, it’s not enough to just high-five and forward the money. A crucial document is a term sheet, which is a draft of the terms and conditions that governs how many shares you’ll get for your money, what rights you’ll have, or how your exit from the investment will work.
Next are legal documents such as the SHA (shareholders’ agreement), which is the contract between the shareholders, and possibly the SPA (share purchase agreement), which is the share purchase agreement. These agreements address issues such as veto rights on important decisions, liquidation preferences (who gets the money first if the startup goes bankrupt or is sold) or anti-dilution (protection against share devaluation if the company gets another investment at a lower price in the future).
Without a lawyer, it’s easy to get lost in this tangle of necessary documents, and a bad contract can mean you won’t see any of your million in the end. We’ll be happy to help you prepare or review them.
The most common trap is to invest based on impression alone. “Those guys were nice” is not a strategy. Without validating the business model, the team and the real potential, you risk funding a dream rather than a business.
Another mistake is investing without any legal backing, such as a proper contract or ownership control. Also, beware of exaggerated promises like “you will earn 10 times in a year” – with startups, 90% of them do not survive 5 years. Experienced investors know that thorough due diligence and strong contractual protections are essential. It’s not just about believing, it’s about knowing.
A promising startup not only has an idea, but also a plan to turn it into revenue. If a business model is missing, it’s a red flag. Other warnings include the following:
Every startup investment is risky, but some are too risky. If something doesn’t seem right, don’t just trust your intuition, rather take the help of a lawyer or an experienced investor.
Tip: Read our article where we have listed the 7 most common mistakes made by startups.
Every sensible investor wants to know exactly what they are getting into. A cap table is the basis, i.e. a table of the owners of the company and their shares. Next, you need to review the articles of association or articles of incorporation, and be clear about voting rights, the ability to raise capital, or who can sell shares.
An ESOP (Employee Stock Option Plan) also deserves your attention. This is a plan for how a startup motivates its key employees with shares in the company. A well set up ESOP ensures that key people stay and keep the company going.
Legal certainty is not a luxury, but an absolute necessity for any investor who wants to keep things under control and minimize risk. Key rights you should have include pre-emption rights, the ability to buy new shares before offering them to strangers.
Another important right is tag-along, which allows you to “tag along” with a larger investor when they sell their stake, so you don’t come up short if one of the majority owners leaves.
Conversely, a drag-along is a tool that allows the majority investor to force the sale of shares to other shareholders if a strategic buyer comes along – a protection in case of a major change in ownership structure.
In addition to these rights, you should also ensure that you have regular reports on the performance of the startup so that you can keep track of how the company is doing and react to any problems in a timely manner.
An investment in a startup is not forever. The goal is for the company to grow over time, gain value, and for you to be able to sell your stake profitably. This is called an exit – the point at which you exit the investment and collect a profit.
This can happen, for example, when a larger investor buys your stake, the company merges with another (merger), or someone buys the whole company(acquisition). In some cases, a startup goes public and sells its shares to the public – this is called an IPO. But this tends to be the exception rather than the rule.
To avoid unnecessary disputes or high taxes during the exit, these scenarios should be well covered in the contract. And not only legally, but also with regard to tax optimization. Without this, you could face an unpleasant loss instead of the dream return.
Tip: Want to set up an e-shop? Mistakes when setting up an e-shop can cost you dearly. When setting up an e-shop, it is necessary to comply with many legal regulations. We will advise you how to do it.
A lawyer is not just someone who solves problems. In startup investing, it’s someone who can help you avoid those problems. What they can do for you:
Startup investments can be very profitable, but they are also extremely risky. Before you enter them, find out what a startup is, understand the basic legal and economic principles, vet the team, and have customized contracts prepared. This is the only way to increase your chances of experiencing the joy of growth instead of disappointment.
Investing in startups can yield high profits, but they are fraught with risks, especially legal ones. A startup is a young, fast-growing company based on an innovative idea – typically without a stable income but with big ambitions. Investors enter them at different stages of development, from the very beginning to market expansion. However, the key is to have well-set contractual terms – from term sheets to shareholder agreements – that ensure, for example, share protection, voting rights or exit. Exit occurs when an investor sells his or her stake to, for example, a larger fund, in a merger, acquisition or, exceptionally, when a company goes public. The risk is not only a failed project but also insufficient legal security – typical mistakes are investments based on perception, without due diligence or without lawyers. In addition to basic documents such as a cap table or ESOP, the investor should have rights such as pre-emption, tag-along and drag-along. A lawyer can help you negotiate favorable terms, protect your interests and minimize tax and business risks. Without legal protection, even a good idea can quickly turn into a bad investment.
The foundation is a working business model, an experienced team and a realistic growth plan. It’s not enough to just have an idea – the investor should also check the legal status of the company, its ownership structure and its ability to monetise the product. If basic questions about finances, team or technology rights are not answered, it is better to stay away from the investment.
The highest yield potential is in the earliest stages (pre-seed, seed), but it is also the riskiest period. Later rounds of financing (Series A and others) carry less risk, but also a smaller stake at a higher price. The choice of stage should match your risk appetite and investment strategy.
A convertible note is a type of loan that converts into a stake in the company at a future date – often at the next investment round. It’s a win-win situation: the startup gets the money quickly without a complicated valuation of the company, and the investor gets more favorable terms when joining the company in the future.
The main risks include loss of control over the stake, devaluation of the investment in new financing rounds (dilution) or inability to exit. Good contractual documentation is key – e.g. shareholder agreement, pre-emption rights, tag-along and drag-along. Without these, even a good-looking investment can be a legal trap.
Exit is the point at which an investor sells his stake and realizes a profit – for example, when a startup is sold, merged or IPOs. For an investor to actually make a profit, the terms of the exit, including taxes, must be clearly contracted. Without these arrangements, even a profitable sale can result in legal disputes or tax losses.
Our team of experienced attorneys will help you solve any legal issue. Within 24 hours we’ll evaluate your situation and suggest a step-by-step solution, including all costs. The price for this proposal is only CZK 690, and this is refunded to you when you order service from us.
Ondřej is the attorney who came up with the idea of providing legal services online. He's been earning his living through legal services for more than 10 years. He especially likes to help clients who may have given up hope in solving their legal issues at work, for example with real estate transfers or copyright licenses.
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