What To Expect in Later-Stage Capital Raising Rounds

In Short

• Later-stage capital raising involves preparing for extensive due diligence, complex deal structures, and negotiation of investor terms.
• Deal structures vary, including equity rounds, convertible notes, and venture debt, which minimizes shareholder dilution but adds repayment risks.
• Common deal terms include liquidation preferences and protections specific to preference shares.

Tips for Businesses

Prepare a thorough data room for due diligence and anticipate detailed negotiations around deal structure and investor rights. Consider the balance between raising capital through equity or venture debt to support growth while minimizing ownership dilution.

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Table of Contents

• 1. Preparing for the Due Diligence Process
• 2. Deal Structure
• 3. Common Deal Terms
• Key Takeaways
• Frequently Asked Questions

Companies often go through various stages of capital raising to facilitate growth. Investors in early-stage capital raises are typically friends, family, and small angel investors. By contrast, more prominent institutional investors and venture capital funds often invest in and lead later-stage funding rounds. These investors make significant contributions to the business, meaning deal negotiations are often more complex. This article explores how to prepare for and what to expect in later-stage funding rounds.

1. Preparing for the Due Diligence Process

Prospective investors in later-stage funding rounds often carry out due diligence investigations before they are willing to commit to investing in a company. This gives the investor greater:

• clarity of the risk profile of the investment; and 
• certainty that it is making an informed financial decision.

Ideally, before or while the company commences preliminary discussions and term sheet negotiations with the lead investor, it should start compiling all of the documents and information that will be included in the data room. The data room is the virtual location storing all of the due diligence materials that the investor will examine. 

What To Include in Due Diligence Materials

Some things the company should include in the data room include:

• a copy of its members register, constitution, shareholders agreement and cap-table; 
• an organisation chart setting out the corporate structure of the group;
• any agreements or arrangements which oblige the company to issue shares, options or convertible securities, such as Employee Share Option Plans, Convertible Notes and SAFE agreements; 
• resolutions and minutes of board and members meetings in the previous three years; 
• a summary of all intellectual property held by the group, including registered and unregistered trade marks, patents, designs, software licences, domain names and copyrighted materials; 
• employment agreements between all employees and the company; 
• IP Assignment Deeds between the company, the founders and each key employee; 
• material contracts with customers, suppliers and government agencies; 
• details of any ongoing or anticipated disputes to which the group is a party; 
• details of any licences and insurances held by the group; 
• details of any financial arrangements, loans and other liabilities of the group; and
• a list of the group’s leased and purchased assets and security interests. 

2. Deal Structure

Deal structure is an essential consideration in any capital raise. As a result, later-stage funding rounds can adopt various forms, including:

• equity rounds;
• bridging rounds;
• using convertible instruments, such as SAFEs or convertible notes; and
• venture debt.

Venture Debt

Unfortunately, venture debt is not available for early-stage companies because they cannot demonstrate the consistent cash flow required to service venture debt arrangements. However, venture debt can be viable for mature companies as the higher interest rate, and lender fees may still be cheaper than issuing equity. In addition, it limits upfront dilution for founders and other shareholders.

Some essential considerations in venture debt arrangements are:

• the lender will likely want to take security over the company’s assets to guarantee repayment, meaning the company’s assets are at risk if it cannot meet its repayments;
• venture debt lenders are usually issued warrants (or the right to purchase shares at a set valuation) to give them the option to participate in any equity upside if the company is doing well;
• venture debt interest rates are generally higher than traditional lending institutions to offset the risk of venture debt lending; and
•  venture debt is not as readily available as an equity investment in Australia as it is an emerging market.

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3. Common Deal Terms

The deal terms of later-stage funding rounds are generally more complex than early-stage funding rounds. Some of the standard deal terms of later-stage funding rounds include the following.

Liquidation Preferences

Companies typically issue preference shares to investors in later-stage capital raising because they have certain rights and protections that ordinary shares do not. As the company grows, it may end up with several different classes of preference shares. So, one of the key terms to negotiate in a new round is whether new preference shares will rank equally with or superior to existing preference shares.  

Ordinarily, liquidation preferences are not a primary concern for founders because the founders are unlikely to receive any proceeds if the company is liquidated. However, the company’s existing shareholders will need to consent to create a new class of shares if the company does not have preference shares on issue. Alternatively, shareholders will need to consent to the creation of a class of preference shares that ranks senior to the other preference shares on issue in the company.

Anti-Dilution Rights

Most preference shares in later-stage capital raising will have anti-dilution rights on down rounds. In other words, the company sells shares at a price per share that is less than the price per share sold in the earlier financing round. 

As the company grows and undertakes further funding rounds, it should be mindful of how these anti-dilution rights interact with the other interests in the company. For example, suppose the company is implementing anti-dilution rights for shares issued in a new round. In that case, it should consider whether it has any existing warrants or convertible securities with a discounted conversion mechanism that may trigger the anti-dilution rights. If so, your anti-dilution terms will need to be structured around this.

Forced Exit Provisions

Forced exit provisions are becoming more common in later stage rounds because investors can be eager to ensure that the company is motivated to achieve an exit within a specific timeframe.

Notably, forced exit provisions can vary and may require the company to:

• undertake an exit within a specific time frame; or 
• compel the company to undertake an exit based on advisers’ opinions.

The time frames in which forced exit provisions are triggered can also vary. However, around 5 to 7 years from the initial investment is customary.

Key Takeaways

Later-stage capital raising rounds are usually more complex than early-stage financings. Mature companies can prepare for their capital raise by:

• organising their due diligence materials; and 
• considering an appropriate deal structure to ensure that completion is not delayed. 

The terms of the deal itself can require significant negotiation as investors may be contributing significant amounts of money relative to early-stage investors. Therefore, the transaction documents are often more substantive. 

If you need help with your later-stage capital raise, our experienced capital raising 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