When you are trying to launch a business, you can’t succeed without money. That’s why startup funding is such a high priority for most founders. While it’s often tempting to take any money offered, the legal implications of how you are funded can make or break a company. When you are looking for capital to build your growing company, you need to make sure that you fully understand all the terms under which you receive funding, as well as all the operational, tax and compliance requirements that may come with any money you do receive.
In order to better understand your obligations after being funded—and to ensure that startup funding you take is in your business’ best interests, it may help to speak with an experienced startup lawyer. A Priori startup financing lawyer can help you evaluate your offer, negotiate your deal and comply with all requirements.
Types of Startup Funding
While many people kick off their startup through bootstrapping and small loans from friends and family, eventually many growing startups need more money to come in. That’s where these formal funding measures come in.
Venture capital funding is one of the most known—and most sought after—forms of startup funding. Venture capital exchanges equity in the company for the investment, which means that it requires complex contracts and contentious valuation processes before any money comes in. Legally, venture capital funding is the most complicated type of startup funding, but it also generally offers the largest investments. If you are considering venture capital funding, you must weigh the costs and benefits of giving up large stakes of the company in exchange for capital.
Angel investors offer capital much in the same way that venture capital firms do, but they are generally much smaller operations—even just a single person. Because of this, angel investors tend to have a much more active role as a mentor and advisor of your growing business. This can be a good thing when you have a solid relationship with the angel investor, but it can also be challenging when there are disagreements about how to best tackle problems facing your company. Legally, contracts with angel investors can vary greatly, so it’s important to consult an attorney about these ventures to ensure that you know exactly what your startup is getting into.
Crowdfunding has become an increasingly popular way to fund startups, especially on online platforms like Kickstarter and Indiegogo. Individuals contribute money, often in exchange for pre-ordering a product or other awards. While this type of crowdfunding may not come under securities regulations, since it is not investment per se, there are significant tax and other legal implications that should be considered before you solicit crowdfunded capital. If you offer rewards or products to people giving money and do not follow through as promised, you can fall afoul of consumer protection laws and be sued for breach of contract. In addition, it’s important to have your company solidly incorporated before participating in crowdfunding, or tax and legal consequences could fall on you as a founder personally.
Small Business Loans
Some startups still turn to banks and other lending institutions for small business loans to fund their idea. Small business loans tend to be smaller amounts, and they require you to account for exactly how the money will be spent. Usually, startups have trouble getting funding this way for unproven ideas, but when it is awarded, the advantage is that you do not have to give away equity in your company. Unfortunately, this option is really only available if you can quickly turn the investment into a revenue stream, as you’ll need to pay back the loan installments—often right away. Unless, you fully understand the terms of the small business loan, you risk a tough lending period or even losing your assets to the bank before your startup is off the ground.
Whenever you are trading equity for capital, a key point of negotiation is your startup’s valuation. Your company’s current worth determines what percentage of shares the investor will be awarded in exchange for the capital given. Because this will ultimately have a major impact on control of your startup, it’s important to work out a fair valuation with investors, no matter how early-stage the investment.
Sometimes, however, fair valuation isn’t possible, especially in early stage startups. In these cases, convertible notes can provide an acceptable alternative. Convertible notes are a financing vehicle that allows startups to raise capital while delaying valuation until a later date—usually during a new round of funding when objective valuation is easier to assess. Convertible notes are structured as loans that convert to equity upon maturation. Because investors are taking on an unspecified valuation, there is some risk involved, which means these investors often require special assurances, discounts or warranties.
When you are soliciting funding, you must comply with all SEC guidelines and other securities laws from the very beginning. This includes making proper disclosures, complying with all tax laws, making regular reports to investors and the SEC, and dealing with all other compliance issues. Far too many startups fail to consider the implications of securities law on early issuances of stock, which can have lasting and costly consequences.
Almost any time that you are securing startup funding, you will be required to sign an investment contract that lists out the terms under which you are given the capital. This investment contract will govern much of how your startup will be able to operate after the investment, and it will dictate the terms of your relationship with your investors moving forwards. It is vital that you fully understand anything contained within these agreements. If you are soliciting funding, it may be helpful to talk over any potential issues and contract terms offered to you with a startup lawyer.
Depending on the financing type and stage you’re pursuing, the legal costs associated with drafting and negotiating the required documents can run a broad range. Priori lawyers offer transparent flat fee packages for various types of early-stage financing ranging from $2000 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 free price quote from one of our lawyers.
Do I have to worry about securities laws if I’m just getting money from my friends and family?
Yes. No matter who is investing in your company, you are still responsible for complying with securities laws. If your “offering” is one that would otherwise be subject to SEC rules, it does not change anything simply because you have a close personal relationship with the people giving you the money.