Financing Types & Stages
There are many different ways to raise money for your business. However, seeking the wrong type (debt vs. equity financing, for example) or source of funds will cost your business time and money and may limit your ability to run your business. Priori is committed to helping you navigate the various stages and instruments of debt and equity financing and helping you find a great financing lawyer so you can make the best choices for your business during the financing process.
Debt vs. Equity Financing
Financing primarily occurs through debt and equity financing.
What is Debt Financing?
In a debt financing, you raise funds by selling debt securities issued by your business. Common forms of debt financing include:
Loans. Typically obtained from a bank or private individuals or entities, a loan is a form of debt financing that allows your company to borrow money today, pay periodic interest on that money and repay it at a specified point in the future.
Revolving Credit Facility. Banks and private individuals and entities may also consider financing your business through a Revolving Credit Facility -- imagine a high-dollar value credit card for your business. Revolving Credit Facilities typically allow a company to withdraw money up to a certain cap amount, as needed. Facilities generally require interest payments on drawn amounts, as well as much lower interest payments on undrawn commitments. Facilities typically specify situations in which the money may be drawn down, as well as situations in which the company must repay the money.
Convertible Note. A convertible note is a form of short-term debt financing that allows an investor to convert debt into equity at some point in the future. The period for conversion is often based on a specified length of time (maturity term), the raising of a specified amount in a future equity round (qualifying financing), or whichever comes first. However, if a company does not meet the trigger or triggers for conversion, the investor can call in the debt and the company must pay the loan back with interest.
- Simple Agreement For Future Equity (SAFE). These instruments convert into equity like a convertible note, but they do not have any debt component. Therefore, the investor receives a note with the option to convert equity some time in the future but cannot call in repayment of the original debt.
What is Equity Financing?
In an equity financing, you raise funds by selling an ownership interest in your business. Common forms of such an ownership interest include:
- Common Stock. Common Stock is generally allocated when an entity is first formed, often to founders and other early shareholders of an entity. The rights associated with common stock vary from company to company and are generally set forth in the Certificate of Incorporation as well as other investment documents. Note that subsequent equity financings often dilute the ownership interests of shareholders holding Common Stock.
- Preferred Stock. Typically issued to investors in your business, preferred stock generally has a range of additional rights and preferences as compared with common stock. A preferred stock financing generally begins with a term sheet summarizing these rights and preferences. The ultimate agreement on these points will be reflected in the Amended Certificate of Incorporation and other deal documents (which can include a Stock Purchase Agreement, Investor Rights Agreement, Voting Agreement, Right of First Refusal Agreement and Director Indemnification Agreement).
- Convertible Preferred Stock. A common type of Preferred Stock, Convertible Preferred Stock provides its holder with the option to convert such Preferred Stock into Common Stock of the business in certain situations and at a previously agreed conversion ratio.
Financing Stages For Emerging Companies
Early Stage Financing
Friends and Family. Early stage financing via friends and family members generally allows very early stage companies to secure more favorable financing terms than such companies would be able to obtain through more formal approaches. Even when you have a very close relationship with your "lenders," written documentation of the early stage financing terms and conditions is a must.
Angel Investors. Angel investors are firms or individuals who provide early stage financing to emerging companies -- generally in exchange for equity or convertible notes. Such angel investors take on a high degree of risk and often seek both commensurate returns and significant involvement with decision-making.
Crowdfunding. A range of websites enable businesses and entrepreneurs looking to raise funds to reach out to thousands of potential investors via their crowdfunding platforms. Some of these sites allow companies to sell equity stakes, while others restrict the exchange to small gifts and other forms of recognition. If you are planning on using equity crowdfunding, a financing lawyer can ensure compliance with the applicable regulatory requirements (generally the Jumpstart Our Business Startups (“JOBS”) Act).
Seed Round. A Seed Round generally supplies a company with a modest amount of capital provided from venture sources intended to help a company transition from initial idea implementation to functioning as a going concern. A range of types of investors participate in Seed Rounds -- from angel investors to venture capital firms. The structure of Seed Rounds varies significantly based on context.
Series A. A Series A round is typically the first significant round of venture capital investment. Because this is still an early stage of investment, investors generally look to receive returns commensurate with relatively high risk.
Series B, Series C and Beyond. Subsequent rounds of financing serve a range of purposes. Some financings support successful companies in efforts to grow and scale. Other rounds support relatively mature companies as they seek to expand into new markets or make themselves more attractive acquisition targets. Still other rounds serve to shore up companies that have experienced some success but also hit stumbling blocks. Pricing and returns for these rounds vary significantly based on context.
Initial Public Offering (IPO)
IPO. The initial public offering represents the first sale of stock by a private company to the public. By “taking your company public,” you can quickly raise liquidity to fund growth plans. Going public can also be viewed as an exit strategy for early investors looking to make high returns on their investment.
Financing Lawyer Pricing
Depending on the financing type and stage you’re pursuing, the legal costs associated with drafting and negotiating the required debt and equity financing documents can vary widely. Priori financing lawyers offer transparent flat fee packages for various types of debt and equity financing ranging from $2,000 to $15,000 depending on the type of financing and number of investors. In order to get a better sense of cost for your particular situation, put in a request to schedule a complimentary consultation and request a free price quote from one of our financing lawyers.
Do I really need a financing lawyer to help my business raise funds?
Your early stage financing decisions not only impact your immediate cash flow and business operations, but also your ability to scale and grow as you succeed. Debt and equity financing documents are generally intricately structured and rife with terms-of-art and specialized language that are crucial to understand. Working with an experienced financing lawyer will allow you to fully understand the financing commitments you are entering into. Just as important, your financing lawyer can discuss appropriate financing sources depending on your specific situation, prepare the legal documents necessary for the financing and advise you throughout the process to help you avoid common pitfalls.
How do you know whether to choose debt vs. equity financing?
Debt and equity financing each have benefits and drawbacks. Equity financing allows you to raise funds without tying yourself down with the obligation to pay back a specific amount of money to investors at a specific time in the future. In exchange, completing an equity financing will likely mean you must give up an ownership stake as well as control over certain kinds of corporate decision-making. Debt financing, on the other hand, allows you to retain control and ownership of your business -- provided that you abide by the terms (including payments of interest and principal). Working with a financing lawyer can help you devise an appropriate financing strategy for your business.