In Short
- Equity: Raise capital by offering investors shares in exchange for funds, while being mindful of shareholder rights and regulatory requirements.
- Convertible Instruments: Use instruments like convertible notes to secure early financing, with potential discounts for future share conversions.
- Loan Obligation: Obtain loans from investors or banks, though this may involve personal guarantees or business asset risks.
Tips for Businesses
Consider your startup’s cash flow and growth stage before choosing a capital-raising method. Equity investment can attract long-term partners, while convertible instruments offer flexible early-stage financing. Loans may provide quick access to funds but often require security.
To raise capital, startup founders can approach:
- government organisations for grants;
- consumers for pre-sales of their product; and
- investors and lenders for financial contributions.
In exchange for the financial contribution from investors or lenders, founders can offer either an equity interest in their company or a debt obligation. This can take the form of a straight equity investment, a straight debt obligation, or a mix of both via a convertible instrument. To help you understand more about startup capital raising, this article focuses on the financial contributions you can gain from investors and lenders for your startup.
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1. Equity
If you choose to undertake an equity investment, your investors will take an ownership interest in your company by purchasing shares in your company in exchange for their investment monies.
However, issuing shares is subject to rules and regulations under the Corporations Act. Hence, you will need to be mindful of:
- the number of people you issue shares to; and
- whether those people are sophisticated and professional investors, or not.
Typically, private companies seek to raise capital in a manner that avoids having to provide a formal disclosure document to investors.
You will also need to be mindful of the rights which your shareholders will have. Shareholders will typically negotiate certain rights, including the right:
- to make decisions over certain matters or veto certain decisions;
- to receive regular business and financial information;
- of first refusal or ‘pre-emptive rights’ over future capital raises or share sales; and
- to a preferential return in the case of an exit event or winding up of the company.
Crowdsource Funding
Crowdsourced funding (CSF) is a method of raising capital which allows private companies to raise funds from the public. Through CSF, companies can offer ordinary shares to retail investors, using licenced intermediary platforms and offering documents. This intermediary will perform several tasks, including checking the offering company and holding onto investor money when the offer is complete.
Nevertheless, it is important to seek legal advice on how appropriate CSF is as a capital-raising method for your startup. This is because a company needs to ensure its governance documents are structured in an appropriate way to be able to raise funds through CSF and manage a large number of CSF investors.
2. Convertible Instruments
Rather than issuing shares to investors upfront, another method of raising capital from investors is through convertible instruments. Convertible instruments include convertible notes or ‘simple agreements for future equity’ (SAFEs), or token warrants.
These instruments can be a useful way of obtaining early-stage financing or bridging finance between larger equity rounds. This allows you to take investment monies from investors upfront in exchange for a promise to convert that money into shares at a future date (usually at set maturity date, an equity financing round or an exit event – whichever occurs earliest).
As an incentive for the investor, the convertible instrument usually contains some sort of discount for the investor, such as:
- a guarantee that the money will convert at a valuation no higher than the set ‘valuation cap’ amount (which will apply even if the company’s valuation at the time of conversion is actually higher than this); or
- an agreement that the investment amount will convert at a percentage discount to the share price at the time of conversion (for example, if at the time of an equity financing, a share price is agreed with incoming investors, the convertible instrument will convert at a 20% discount to that price).
3. Loan Obligation
You can approach investors, private lenders or banks for a loan to pursue your startup dream. Most lenders require security for the loan, such as a personal guarantee, which can put a founder’s personal assets at risk. Sometimes lenders may require the company to provide security over the business assets, which means that if the company defaults on the loan, the lender can take control over the business assets to satisfy the debt owed. You will also require sufficient cash flows to repay your loan, and the interest accrues.
Loans can be structured in several different ways, such as:
- a term loan requiring a lump sum repayment at the end of the term;
- a facility or credit line, where the company can draw down on funds as and when it needs up to a facility limit; or
- revenue-based financing, where the repayment amount each month is calculated as a percentage of the company’s revenue for the preceding month.
Key Takeaways
When raising startup capital, you can approach investors and lenders for financial contributions. In exchange for the financial contribution from investors or lenders, you can offer either an equity interest in their company or a debt obligation. This can take the form of a straight equity investment, a straight debt obligation, or a mix of both via a convertible instrument.
If you have questions about raising startup capital, our experienced startup lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers to answer your questions and draft and review your documents for a low monthly fee. Call us today on 1300 544 755 or visit our membership page.
Frequently Asked Questions
Crowdsourced funding (CSF) is a method of raising capital which allows private companies to raise funds from the public.
Convertible instruments allow you to take investment monies from investors upfront in exchange for a promise to convert that money into shares at a future date.
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