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So, you’re looking to raise capital for your startup. It is important to first ask yourself what you need the funds for and whether other funding options are more suitable for this purpose. You should consider raising funds by issuing equity if you need more capital to grow your business. Issuing equity is also helpful if you use up your own funds and need capital to continue operating. If you think now is the right time for your startup to raise capital, you will need to pitch your business to potential investors. This article will explain:

  • the right time to raise capital;
  • information that potential investors look for; and 
  • how you should structure your equity raise.

When Is the Right Time to Raise Capital?

When considering the right time to start raising capital, there are some questions you should ask yourself. 

  • Have you run out of cash to continue to self-fund your startup? 
  • Are you hesitant to risk your personal assets through leveraging your home mortgage?
  • Are you unwilling to take on additional risk by opening up a line of credit? 

Before diving into the capital raising process, also consider if bootstrapping is a better option for your startup. If your startup is growing well with the revenue it is generating from your customers or clients, and this is sustainable, then getting cash into the business from external investors (who will dilute your equity stake) may not make sense.

Your startup should not raise capital just because it is a startup. It should do so to increase its value and project its growth. Consider bootstrapping for as long as you can. If you do eventually invite an investor onboard, you will be doing so when you have gained traction and have a higher valuation. At this stage, you should be able to show your market position, returning clients, and most importantly, growth. You will have a clearer business model and be in a better position to sell your idea and convince an investor that they can expect a good return on their investment.

However, if you believe your startup is at a point where funding from external investors is crucial, you must also consider the timing of your capital raise. Two key elements to consider are: 

  1. raising before you are too close to the end; and
  2. raising when you have a milestone to celebrate (and boast about) with potential investors.

Ensure you are in a position where investors will feel like they would be missing out if they did not invest in your startup.

What Do Investors Want to See?

So you’re ready to start pitching to investors. However, before you start pitching your startup to every investor in town, it is a good idea to build a basic financial model for your startup. This model should map out how much cash you will need to get you to your next business milestone, how much for the one after that, and so on. Build this financial model to understand your business’ short-term and long-term capital needs but do not feel bound by it. Ultimately, have a plan for profitability and determine how much cash you will need to get you there.

Additionally, it is crucial to understand your startup’s growth projections, pitch and legal structure. These are explained below. 

Growth

What differentiates a startup from other businesses is the focus on exponential growth rather than profits. If you are close to running out of cash but your business has significant potential, such as a highly engaged client base or access to lucrative or niche markets, you may want to consider raising funds to capitalise on this growth opportunity.

Equally, when your business needs funds to grow or to reach a significant milestone, you should consider raising capital. This provides an enticing offer for new investors to join your company and come along for the ride at an exciting time in the life of your business.

The Pitch

Firstly, perfect your slide deck. Ensure it is punchy and concise. This can be done professionally and often results in dollars well spent.

Secondly, ensure that you engage a professional to verify all the statements and figures in the slide deck. Investors will want proof of any claims you make about the value of your business and financial projections. 

Legal

Additionally, ensure you correctly set up your legal structure, so investors know what structure they are investing in. This often involves incorporating a company to run your business. It may be advisable to have a dual company structure to protect the key assets of the business from claims against the operating company.

We advise having a watertight shareholders agreement in place before raising capital. This ensures that you, as the founder, will be in control of your company after the raise. 

A step in the legal process will be to negotiate a term sheet, setting out the key commercial and legal terms of the investment into your company. We recommend that you prepare the first draft of the term sheet to ensure your position as a founder is represented and protected. Likewise, make sure you fully understand the key commercial and legal terms and their implications.

What Is Standard?

Lots of startups follow a similar pattern when structuring their raise. That is not to say you must do so as well, but it is helpful to know how rounds are commonly structured and what terms such as ‘seed’ and ‘series A’ mean.

Round Description
Family and Friends Typically, the first place a startup looks when raising capital is close to home. Obviously, this is not suitable for everyone, but having friends and family invest in your startup early is quite common. Bear in mind that your friends and family are not professional investors – make sure that they are getting a fair deal.
Seed Round Your seed round investors will be angel investors. An angel investor is someone who invests smaller amounts of capital into a range of startups, expecting many to fail but one or two to do well. A great way to meet angel investors is through networking, but you can also consider approaching angel groups such as Sydney Angels or Melbourne Angels. Typically, you will raise this round through equity or a convertible note structure.
Series A If your startup has come out of its seed round and is continuing to grow, it might be the right time to up the ante and approach a venture capital fund to lead a Series A round. This round should occur in conjunction with the development of a robust business plan with a focus on an ultimate path to profitability and return on investment.
Series B and beyond Subsequent rounds like series B and C occur when your business has moved beyond the development phase and is ready to expand substantially (commonly internationally). Often, it will involve existing investors injecting more capital into the business. Remember that the number of rounds your startup raises is not a measure of your success!

How Do I Structure the Capital Raise?

There are three possible structures for an equity capital raise:

  1. equity round;
  2. convertible notes; and 
  3. simple agreement for future equity (SAFE).

Equity Round

An equity round involves founders issuing investors shares in the startup in exchange for cash. With an equity round, the key areas of negotiation will be:

  1. your startup’s pre-money valuation, and
  2. investor protections such as the type of shares they can receive and their ability to vote on or block commercial decisions.

Your startup’s pre-money valuation will determine how many shares the investor will receive in exchange for its cash and what percentage shareholding each shareholder will end up with after the raise. When assessing your startup’s pre-money valuation, we advise obtaining professional advice. This way, you have the numbers to back up your valuation. 

Convertible Notes

If it is difficult to accurately value your company at this stage, you may want to raise funds by issuing convertible notes before your seed round. Convertible notes can also be helpful when raising bridging finance between rounds. This allows the company to take on external investment without the founders giving away any equity until you can properly value your company at a later date.

A convertible note should specify:

  • how much someone is investing;
  • what interest is payable;
  • when the loan will convert into shares (usually when there is an equity fundraising, an exit event, a liquidation or at maturity of the note);
  • what discount rate will apply to the issue price of the shares; and
  • the valuation cap (if any).

It is important to note that, as debt is regulated, you should ensure you comply with any applicable regulations when issuing convertible notes.

SAFE

A SAFE is similar to a convertible note minus the debt element. 

In consideration for paying a cash amount to your startup, an investor receives a contractual right to receive equity in your startup when a predetermined trigger event occurs. The trigger events are generally the same as those found in a convertible note, except that SAFEs often do not have a maturity date.

The advantages of raising capital using SAFEs, as opposed to convertible notes, are as follows:

  1. SAFEs do not have a maturity date. This means that the investor has to wait for a trigger event to occur before it receives shares;
  2. interest is not payable on SAFEs. Hence, the complexities involved in converting interest into equity does not apply, and the company will give away less equity when the conversion occurs; and
  3. SAFEs are not debt and therefore are not regulated.

Key Takeaways

Raising capital presents an exciting opportunity for your startup to help accelerate its growth, reduce your personal risk and bring on new strategic investors. The key points to consider when raising capital are: 

  • current risk; 
  • future growth; 
  • structuring the raise; and
  • the terms of the investment and extent of control given to investors. 

If you would like more information on the best method to raise capital for your startup, contact LegalVision’s capital raising lawyers on 1300 544 755 or fill out the form on this page.

Frequently Asked Questions

What does it mean to raise capital for my startup?

Raising capital for your startup means getting money from investors to grow your business. In building your startup, you may reach a point where you have run out of your own personal funds. Hence, you will need to raise capital to continue operating.

When is the right time to raise capital for my startup?

If you are considering raising capital for your startup, the first question to ask yourself is, have I run out of cash to continue to self-fund my startup? Next, consider if you are unwilling to risk your personal assets, like leveraging your home. If the answer is yes, it might be the right time to raise capital for your startup.

What is an equity capital investment?

An equity capital investment is when an investor purchases shares in your company at an agreed valuation. The hope is that your business will grow in value, and they will see a return on their investment when they sell their shares.

How should I structure my equity capital raise?

You can structure your capital raise through an equity round, convertible notes, or a simple agreement for future equity (SAFE).

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