As a startup looking to get off the ground, raising capital through equity can be a great way of securing funds. Your success will typically depend on how well you sell your idea, business and team. To assist you in the process of raising capital, we put together an equity capital raising checklist:
Set up a Dual Company Structure
Before investing in a startup, professional investors will check to see that your business has a dual company structure because:
- They want to see that the structure of your business protects its assets. They want to see that an operating company takes on liabilities by entering into contracts and that a holding company holds all business assets.
- A dual company structure ensures that investors won’t take on unnecessary liability. While a single company structure directly exposes their investment to the liabilities of the business, a dual company structure does not. An investor wants to ensure their shares and the valuable assets of the business are kept separate from these liabilities.
Quick Tip: Before you restructure your business, keep in mind that any transfer of assets or shares may have tax implications. You should seek tax advice before making any changes to your business structure.
Protect your Intellectual Property (IP)
IP is a valuable business asset. Consequently, investors will want to see that you have taken steps to protect your business’ IP. IP can include:
- Patents – your tech or your product;
- Trade marks – your brand name and logo;
- Copyright material – your code, your designs and your written material; and
- Trade secrets – things that you keep confidential but they do not have formal protection.
Quick Tip: Speak with an IP lawyer before completing any trade mark or patent applications. It’s not worth spending your money on fees if IP Australia rejects your application – especially if the reason was for something you could have avoided with professional advice. An IP lawyer can also provide guidance on how to protect your IP if, and when your business expands internationally.
Assign all IP to the Business
Investors want to see that the company they are investing in owns the IP they have developed. If another entity legally owns the IP of your business, it should be assigned to the holding company before you raise capital.
Another entity may legally own IP where:
- An external developer writes the software or develops your tech. In this situation they own the IP they create unless they sign a development agreement assigning ownership of the IP to the company;
- The founders began the development of the IP (e.g. code, website copy or a business plan) before registering the business. Subsequently, they failed to transfer the IP to the business after registration; and/or
- The founders applied for a trade mark or patent under their name rather than the company’s name. Consequently, the company is not the legal owner of the registered IP.
How? You can draft an IP assignment agreement assigning the IP rights from any third parties to the holding company. A founder can also change the owner of a trademark through IP Australia.
Quick Tip: If you worked with a developer to develop your business’ IP, check your development agreement to ensure that the IP has been assigned to the holding company.
Consider an Employee Share Scheme (ESS)
ESSs are not compulsory, but a lot of startups use them to incentivise key employees, contractors and directors. Under an ESS, an employee will be granted shares in the holding company or options to subscribe for shares in the holding company. It is common for startups to provide options that convert to shares in the future.
Investors like to see ESSs in place because they incentive employees to commit to the business long-term. Further, they assist startups in securing quality talent. However, investors also like to know upfront the size of the total ESS pool. Such information ensures they are aware of any potential dilution to their shareholding as a result. An equity capital raising term sheet and shareholders agreement typically set out whether a business has an ESS.
How? It’s important to speak to a startup lawyer about putting an ESS in place as you will need:
- ESS plan rules and offer letter;
- Employment/contractors Agreements; and
- A shareholders agreement (especially if you are granting shares at the outset).
Quick Tip: It is likely that setting up an ESS requires the approval of all shareholders, so you should speak to your co-founder/s beforehand. You should also talk to your accountant or tax advisor before implementing an ESS. Doing so will help determine whether your company is eligible for an ATO compliant ESS and allow you to understand the tax implications of implementing the ESS.
Draft a Shareholders Agreement
Investors will always check whether you have a shareholders agreement in place. This essential legal document sets out the relationship between the existing shareholders in the holding company. If you have multiple shareholders in your company, a shareholders agreement should be in place early on. It should cover key matters such as issuing or selling shares, decision making parameters and dispute resolution.
It is not uncommon for a professional investor to require a new or amended shareholders agreement containing terms that will protect investor interests (for example, specific investor veto rights), which will be entered into by the investor and all existing shareholders as part of the capital raising transaction.
How? Given the importance of this document, you should speak with a lawyer about preparing your shareholders agreement.
Quick Tip: Professional investors often require a business to change their existing shareholders agreement or put a new one in place as a part of the capital raising transaction. Depending on the level of bargaining power of your investors and the size of your capital raise, it may be more efficient to draft your shareholders agreement as part of the capital raising negotiations, instead of drafting it without the investors’ input and then having to make substantial changes to accommodate your investors’ requirements.
Prepare a Pitch Deck and Disclaimer
Your pitch deck is a presentation about your startup and capital raise. It is used (sometimes along with an information memorandum) when there is no requirement for formal disclosure documents under the Corporations Act. It should contain all the critical information an investor needs to know about your startup before investing. While you should ensure that all information included in the deck is true and not misleading, it should also contain the appropriate disclaimers (for example, statements of non-reliance) to protect your business from any claims arising as a result of misleading and deceptive statements. You should also avoid the including forward-looking statements in these materials.
How? While each business is unique, it is essential to cover these key points throughout the pitch.
Quick Tip: Once you have drafted your pitch deck and/or information memorandum you should have a startup lawyer review it along with your disclaimer. You want to make sure that you do not provide misleading information as part of your pitch.
If you have any questions about our equity capital raising checklist or need assistance with raising capital for your business, get in touch with one of LegalVision’s startup lawyers on 1300 544 755.
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