- From idea stage to IPO, there are a number of different startup funding methods to fuel growth of a business.
- Each stage of funding (unless you raise debt finance) requires giving up equity in the company. Each person or entity owning equity becomes a co-owner of the company.
- Startup founders need to negotiate a pre-money valuation with investors at each round. It’s important to strike a balance when valuing your startup.
Startup Funding Rounds
Unless you intend to bootstrap your startup for the entirety of its lifespan, understanding how startup funding rounds work can give you a better idea of how to grow your startup with the help of external funding. Every time you receive funding, you give up a piece of equity in your company. Everyone you give equity to becomes a co-owner of your company. This is a regulated area, we can assist with fundraising law advice and steps including who shares can be offered to, legal documents, and managing your risk for the pitch deck or IM.
At the idea stage, it is just you and your idea. You create value as soon as you start working on it, which will translate into equity later. However, as the idea is not even a registered business, there is no real value attributable at this stage.
As you transform your idea into a reality, you may decide to bring on other people to assist you in growing the business. A co-founder (or co-founders) is likely to be someone who shares your vision and brings a useful set of skills and experience to the business. While you may not be able to offer a salary at this stage, you can offer equity in exchange for work, also known as sweat equity. You may decide to register as a company at this stage, and issue some common stock to divide equity.
Family and Friends Round
To grow the startup, you may reach out to family and friends as potential investors. At this stage, as you are operating as a private company, you are not in a position to raise public investment as this violates financial securities laws. Family and friends can offer personal funds in return for equity in the company. The main advantage of raising from family and friends is that you already know them.
At a seed round, you open up for angel investors or venture capitalists to contribute significant capital in return for equity in the business. Angel investors should be accredited investors. Venture capitalists persuade other people to put money into their funds, and in return, they aim to invest in profitable ventures. At this stage, startups often look to work with an incubator or an accelerator. These organisations will provide cash, working spaces and advisors in return for equity in the startup. Seed firms are similar to angels in that they invest relatively small amounts in various stages. Seed firms differ from angels and VCs in that they invest exclusively in the earliest phases.
Often your first venture capital round is your Series A. Startups may be large enough at this point to bring on employees, who may accept low salary plus some stock. A term sheet should be draw up. This document will formalise the terms under which investors will invest.
Series B, C, D etc.
Depending on the growth of the startup, you can choose to have more series rounds for investment.
Initial Public Offering
An IPO allows the general public to buy stock in your startup. An IPO will enable your business to raise a large amount of capital from the public, and will also provide your investors with an exit opportunity. Investment banks are often involved in preparing IPO paperwork and acting as underwriters.
- Equity funding enables a startup to raise capital in exchange for ownership interest and is focussed on raising operational capital that helps a startup grow the business.
- The seed round is often used to build the product, Series A to build the business and Series B onwards to scale the business. To get to a seed round, the founders need to convince the investors that they are worth investing in.
- Crowdfunding requires adhering to the guidelines set by ASIC. Types of crowdfunding that involve offering or advertising a financial product, providing a financial service or fundraising through securities require a complying disclosure document.
Alternative Methods of Startup Funding
Bank Loan or Line of Credit
A bank loan or credit card line of credit can provide short-term capital to allow the business to manage its working capital. You will require a good credit history or existing assets to obtain these sources of finance. Banks will often request a solid business plan including your revenue expectations.
Revenue based financing allows investors to inject capital into a business in return for a percentage of ongoing gross revenues until the capital amount, plus a multiple, is repaid to the investor.
Crowdfunding websites allow anyone to make an online pledge to your startup during a campaign. The law as it relates to crowdfunding in Australia is in a state of flux.
Small Business Grants
There are a number of state and federal government grants allocated to small to medium businesses, especially startups or companies operating in the Research and Development space.
Frequently Asked Questions about Funding Startups
Q: What is bootstrapping?
A: Bootstrapping a business means relying on personal income and savings, sweat equity, lowest possible operating costs, fast inventory turnaround, and a cash-only approach to selling.
Q: What is an option pool?
A: An option pool is where stock in a company is set aside for future employees or investors. This is usually 10 to 20% of the company.
Q: What is the ESVCLP?
A: Early Stage Venture Capital Limited Partnership (ESVCLP) is a Program of the Government of Australia. Eligible venture capital funds can register as an ESVCLP. Businesses with assets of less than $50 million may access venture capital under this program.
How can LegalVision help me?
We have helped many Australian startups grow their business and meet their legal obligations. It would be our pleasure to assist you. We provide fixed prices for your certainty and peace of mind. Call LegalVision today on 1300 544 755.