Table of contents
Part 3.2 of the Startup Playbook Series.
In part 3.2 of the Startup Playbook Series, we look at high level questions to ask yourself when raising capital and negotiating your first rounds.
Raising capital
One of the hallmarks of a startup is the need to raise capital to grow and scale. Whether your venture is looking to run tests or trials, buy components or ingredients – money for the next step is critical.
How do startups raise capital (read: get money)? Capital raising occurs under two main umbrellas – debt financing, and equity financing.
Debt Financing
Debt financing (read: loan or borrowing) for ‘larger businesses’ often means borrowing from a bank. More often than not, startups don’t tick the boxes of big banks and so obtaining loans from banks can be difficult.
Startups who don’t want to go down the equity financing path often look to convertible notes instead. A convertible note is a contract with a lender (often a high-net worth individual) who will lend a startup a fixed sum, for a fixed interest rate, for a fixed period of time. A convertible note can either be repaid (principal and interest) at the end of that fixed period, or it will convert into shares in the company.
Equity Financing
Equity financing (read: selling shares in the company) is the primary vehicle for startup capital raising. Equity finance can take different forms, depending how far along the business is in its journey. Businesses that are new and full of promise but are yet to demonstrate their value are very difficult to value. Therefore, it is difficult to ascertain a fair and reasonable share price, both for the investor and for the company.
In late 2013, the American accelerator, Y Combinator devised the Simple Agreement for Future Equity, or SAFE, addressing this consideration. SAFEs operate by allowing investors to provide startups with their money upfront, in exchange for the right to obtain shares in the startup at a discounted rate in the future (often the next capital raise, where the business can be valued more accurately, whereby shares are sold at a fixed price per share). The SAFE has been adopted by the Australian startup ecosystem as a useful instrument for early-stage investment, and there have been multiple versions of SAFEs released since then
Once startups have put a few runs on the board – put a product to market, have a customer base, and are generating revenue – they get to the stage where equity financing can happen by way of a priced round (read: selling shares at a fixed price). When undertaking a priced round capital raise, there are a range of laws, rules and stakeholders to be considered.
Things to consider when raising capital
- What powers do the directors have?
- What process needs to be followed to issue the shares?
- What, if any, say do shareholders have on incoming shareholders?
- How are shareholders’ pre-emptive rights being addressed?
- Are there any timeframes for the issue of shares?
- Are the Shareholders Agreement and Constitution inconsistent with one another?
- What are the obligations of the directors regarding the Corporations Act 2001 (Cth)?
- If there are any proposed changes to the Shareholders Agreement as a condition precedent as part of the priced round raise, how is this approved?
- Who are the investors? Are they friends and family – or high-net worth individuals?
- What are the different disclosure obligations?
- What percentage of shares am I comfortable giving away in exchange for capital?
Even if you’ve gone through a pre-seed or seed round before, you might find the next round to be another level of challenging. New investors, new calculations, and new negotiations means each round will come with its own unique features and considerations. The legal takeaway? All Shareholders Agreements and Company Constitutions are different, so whilst all priced round capital raises follow a similar process, the devil is in the details.
Read on to Part 4 Employees & Contractors.
We love helping founders raise capital to take their venture to the next level. Get in touch with the Burch&Co Startup & Capital team to help support you during an often stressful, and also exciting, time for startup founders.
