What’s Involved In Capital Raising?
So you’ve started a business and you’re looking to raise some capital. Capital raising, whether it be from friends and family, or from investors, can provide significant growth opportunities if your business is looking for the next step forward.
Capital raising is a complex process, from designing an investment structure and negotiating the terms of the deal, to preparing the legal documentation and completing corporate actions. We can walk you through your options and the best way to protect your company while achieving your business goals.
When Should I Start Thinking About Capital Raising?
It is important to know that the moment you start raising capital, there are extra stakeholders in your business. Raising capital can be a daunting process, but it has the potential to be extremely fruitful.
Businesses that may benefit from capital raising include:
- High-growth businesses: businesses that have high-growth potential and will scale quickly are very attractive to many investors
- Businesses that need a large amount of funding: receiving funding from investors or venture capitals can, in some cases, be more successful than conventional debt financing sources, as they are willing to invest substantial amounts of money into businesses with potential
- Businesses whose funding isn’t urgent: receiving equity funding can be a lengthy process – it’s more than just filling out an application form!
The Different Types Of Capital Raising
Debt capital is a means of funding where a company borrows money and agrees to pay it back at a later date. The most common types of debt capital used by companies are loans and bonds. While this may be a quick way to gain some funding for your company, it comes with a downside – interest. This interest is due to the lender regardless of business performance and revenue.
Equity capital is generated by selling shares of company stock, rather than borrowing money. In this case, the company is not required to repay the shareholder investment. The returns to the investors goes in the form of payment of dividends and stock valuation.
Convertible Note Raise
Raising capital for your company using a convertible note is a combination of debt and equity financing. Convertible notes are originally structured like debt instruments, but have a provision that allows the amount invested (and if agreed, interest) to convert into an equity investment at a future date.
A SAFE raise uses a SAFE Note which involves the payment of an agreed sum of money, without the debt element. Similar to convertible note, it converts into equity in the future. Under this, an investor agrees to make a cash payment, that isn’t a loan, and is given a contractual right to convert this amount into shares when a pre-agreed trigger event occurs. As this payment is not considered a loan, interest does not accrue and if the conversion event is not triggered, equity is not issued and the payment is not repaid.
What Documents Do I Need For Capital Raising?
Depending on the type of raise you’re using to secure funding for your company, different documents are necessary to protect yourself and your investors. The key terms of the investment are often agreed on through a short-form document called a Term Sheet before proceeding to the below long-form, legally binding documents.
Loan Agreement – This agreement will be necessary to capture the deal you and your investor have agreed to. It will include provisions pertaining to the principal, interest and repayment schedule. It will also address the consequences of late repayment or default.
Security Agreement – If there is a security, a security agreement will also be needed. A Security Agreement is usually signed in connection with a loan agreement, and it allows a party a right to hold a security interest over all past and future property of a business. This agreement allows the lender to register their security interest and make a claim over the secured property in the event the borrower defaults on the loan.
Share Subscription Agreement – This agreement is necessary to capture the relationship between your company and the investor. It outlines the promise made by the investor to make payments of funds in return for a determined amount of shares at a certain price.
Shareholders Agreement – This is an important contract between business owners that governs how decisions are made, what happens when a shareholder wants to leave the company, how disputes are handled and other important matters. This is essential to your business, particularly as the stakes become higher.
A Convertible Note is an agreement under which an investor lends money to a business, which is convertible into equity upon the occurrence of a specific event – usually in anticipation of an upcoming equity round.
SAFE Note – SAFE Notes are similar to Convertible Notes in that both instruments can eventually be converted to equity. However, the key difference is the flexibility and simplicity SAFE notes offer as they are not recorded as debt instruments.
At the equity round, both Convertible and SAFE Notes allow the investor to convert their debt into shares at the same price as incoming investors minus a ‘discount’ which they receive in consideration for investing early.
Need Help With Raising Capital?
It is a good idea to get a lawyer to assist you with this process, as there are many risks your business can be exposed to. At Sprintlaw, we have a team of innovative startup lawyers who can assist you from giving legal advice to drafting your legal agreements.
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