• Steve Davey

How can I raise money to get my company started?


If you can't fund your business yourself, then you'll need an investor.

Investors will dilute your shareholding in your company. So you should only get an investor if you absolutely need to, or if it will help you to take advantage of a lucrative business opportunity.

As a general rule, don't give away shares to business advisors. Only give away shares to investors who pay for the shares. You're probably going to need multiple rounds of investment to keep your company alive.

Investment Rounds

The "seed round" is the first investment round for a startup. The seed round friends, family or angel investors.

The "series A round" occurs after the seed round and is usually larger in scale. Generally, angel investors, micro-venture capitalists or institutional venture capitalists invest in this round.

The "series B round" occurs when occurs when the startup has moved beyond the development phase and is ready to substantially expand. Often it will involve existing investors injecting more money into the business.

Angel Investors

Angel investors can help with the seed round of investment. They will usually supply somewhere between $200,000 and $2,000,000.

It's best to give away only around 10% to 25% in the first investment round. First-time founders often give away too much of their company at the seed stage, or accept an investment amount which is insufficient to launch the company. Most startups die because they run out of cash before they become cash-flow positive.

The best kind of angel investor is already in your industry and can immediately see your vision. They can open up doors to customers and other larger scale investors.

When considering an angel investor, speak to other companies that the investor has worked with.

Ways to obtain investment

There main ways to obtain investment are:

(1) a sale of your equity;

(2) convertible notes;

(3) simple agreement for future equity;

(4) loans; and

(5) crowd-funding.

Each way has its pros and cons, as explained below.

Equity sale

Founders can issue investors with shares in their company in exchange for cash.

The investor will want to know your valuation of the company, and how they can protect their investment if the company fails.

For example, if you value your company at $1,000,000 and you're willing to sell 25% of your shares, then the cost of those shares will be $250,000.

The investor may want to be a director, or have the right to veto certain decisions.

However, you will need to ensure that the investor doesn't have the power to oust you from the company at their whim.

You should try to maintain control of the day-to-day operations of the company.

Convertible Notes

A convertible note involves an investor making a loan to the startup which converts to equity if the founder achieves a certain goal.

Some relevant questions for convertible notes are:

  • What is the term of the loan?

  • How much is being invested?

  • When the loan will convert?

  • What happens if term of the loan expires?

  • What interest rate applies to the loan?

  • How quickly will the startup have to repay the loan?

  • Will it automatically convert to equity?

  • What is the conversion rate?

  • Will the interest convert into equity?

  • Does the convertible note have a ‘valuation cap’ (i.e. a maximum price on the note that will convert into equity)?

Be wary of anyone who offers you a convertible note. If they're a sophisticated investor, then they make a call on the loan and, if you can't pay, they can wind the company up and buy its assets from ASIC. They may force you to sign an agreement that requires you to hand over the company if you can't pay the loan.

Simple Agreement for Future Equity (SAFE)

In a SAFE investment, the investor receives a right to receive equity in your startup when reaches a predetermined goal. The SAFE is not a debt. Interest is not payable. If the startup becomes insolvent before achieving the goal, then the startup agrees to pay the investor an amount equal to its investment before making any payments to its shareholders. SAFEs do not have a term, which means that if the goal is not reached, then the investor will never receive shares. Generally only government organisations offer SAFE investments.

Loans

The advantage of a loan is that it won't dilute your equity. The lenders won't take over the decision making of the company.

If your company has a contract for a major deal that it can't fulfill without funding, then a loan is a good option.

Banks will typically only fund profitable, asset-rich businesses - not startups. Banks also require the director to give a personal guarantee for the loan (that is, the bank wants to sell your house if you can't repay the debt).

However, you don't have to get a loan from a bank. You can get a loan from any organisation. Some organisations will take a general security over the business’ assets without any personal or director guarantees.

A typical loan arrangement:

  • is for three years,

  • with a two year extension;

  • has an interest rate of around 10%-13% per year; and

  • requires regular reporting to the lender.

Legal Documents

Ask anyone who has failed in a start-up, and they will tell you why you need written agreements. If the rules are not clear from the start, you won't be able to avoid or resolve disputes in the future. A lawyer should always be engaged to help you understand and craft the right terms for your situation.

The basic agreements that you will need are as follows:

Term Sheets

The questions that arise in a term sheet are as follows:

  • How much is the investor investing (maximum and minimum)?

  • Can you raise more from other investors?

  • What is the valuation of the company?

  • Will the founders’ shares vest? In a typical scenario if you stop working for the company within 12 months, 25% of your shares will automatically vest; a further 25% of the founder's shares will then vest at the one year anniversary; and the remaining 50% will vest over the next three years, generally on a monthly schedule.

  • Will the investor/s have a board seat?

  • What control will the investor have over decision making?

  • Will you be setting up an employee share option plan?

  • How will the employee share option plan affect the valuation? When an investor says they’ll invest $1 million, they usually mean $1 million inclusive of any employee share option plan. If you’re setting aside 15% of your stock for employees, this means the real pre-money valuation your venture capital is offering you is $900,000, not $1,000,000. If you’re looking for a $1 million valuation not inclusive of the employees shares, you’ll need to negotiate a higher valuation, say, $1.15 million.

  • What anti-dilution rights will the investors have? If possible, you want to avoid offering anti-dilution rights to investors so that all shareholders are diluted (pro rata) when the company issues additional shares.

  • Are you issuing preference shares?

A preference share is a share which entitles the holder to a fixed dividend, whose payment takes priority over that of ordinary share dividends. If so, what level of liquidation preference will you be offering? (1 x non-participating is standard - anymore is unfair).

If the company issues shares at a lower share price than the share price the investor pays in the future, some investors will require additional shares reflecting an adjusted share price (of all their preference shares). The adjusted share price will be calculated by the average of the price they paid and the lower price paid by the later investors.

If you’re issuing preference shares, it is unlikely you will be offering preferential dividend rights. However, if you have to, you want to offer non-cumulative rather than cumulative preferential dividend rights. Non-cumulative means that if the company does not pay a dividend in a particular year, then the investor loses its right to receive a dividend. On the other hand, cumulative means that even if the company doesn't pay a dividend that year, the investor carries over its right to receive a dividend. The company must then pay the investor all dividends before paying any ordinary shareholders.

Shareholders agreement

This agreement sets out the rules for directors and shareholders, including the rules for issuing new shares, the sale of existing shares, directors duties, the conduct of board and shareholder meetings, and dispute resolution mechanisms.

You can have your shareholders agreement drafted before looking for external investment or when raising a round of investment, based on your term sheet.

Subscription Agreement

A subscription agreement formalises the terms of the investment with the investor. It specifies how many shares the company is issuing, the subscription price for those shares, when the startup will issue the shares, and company warranties (statements which an investor can rely on).

Assignment Agreement

Founders typically own their intellectual property in the early stages. Investors will require you to assign the intellectual property to the company they're investing in. An assignment deed will be required to transfer the ownership of the intellectual property to the company.

You may also need an assignment agreement if you use external developers without a development agreement, or incorporate a holding company to hold the assets of your operating company.

Employment Contracts

Some startups will raise a round without the founders having signed employment contracts, but this is rare. Investors want to make sure the startup has employed its founders.

Capitalisation Table

Your capitalisation table is a spreadsheet that sets out who owns shares in your startup.

You have to accurately record all transactions that affect the valuation of a company such as option issuances, sales transfers, conversions of debt to equity and any exercises of options. We have built a cap table spreadsheet for founders to record options.

We can help you to prepare a capitalisation table.


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