So, you’re looking to get your business funded by friends, family, angels or Venture Capital. Or, you already have interest and are now needing legal help. Worry not – it’s not as complicated as it first seems.
You’ll find below top tips on process and general advice I’ve learned by being part of over 500 funding rounds for startups.
First, have a good idea of how much money you need and don’t just ask for heaps for the sake of it. As tempting as it undoubtedly is to sit on a pile of money, chances are the amount you actually need isn’t as much, or on the contrary, you’re really underestimating how much you need. Having said this, when calculating the amount you need, arrive at your final figure, then add approximately 10-15% as a cushion. There will be unseen costs that you haven’t considered.
Don’t just get external funding for the sake of it. Although it may seem like boring advice, take it from an old sage: sometimes funding turns out to be more of a burden than a blessing.
Second, get your business plan straight. There is a high chance that after you began trading, things started to deviate from the initial path you had in mind as you responded to market demands. Of course, this is natural, but for an investor that is weighing up the positives and negatives of your business, they will want to see a full and detailed business plan. Not just a one page spread in your general direction: an in-depth file comprising data, accounts, and projections. It will need to have a proper layout too with an executive summary and appendices. It is important to get things like this right and if you haven’t done them before, there is loads of guidance online about how to write them. This is your chance to put forward your best case for your company: get it right!
Investors don’t need to see your business plan right away. Start with a one pager, short pitch. Once the interest is there, then pull out the business plan.
Third, network and create a list of investors you want to target. Tailor your approach to different investors. Look at their investment histories – the sort of companies they have invested in in the past and the trends and traits they look for in startups. Your investor will likely be part of your business in the long term. Make sure that your interests are aligned, that the deal is a ‘win-win’, that clear expectations are set on both sides. The foundational pillar of any relationship is honesty and communication. Your investor is no exception.
Know that your investor will do their due diligence on you. Normal. Less common but highly advised – do your due diligence on them! Speak to the CEOs of previous startups they invested in. Has the investor delivered on their promises? How is the relationship? Should you have any reservations? And be transparent about this with your investor. If they’ve got nothing to hide, they will have no problem with this and even respect you for your diligence.
Anyway, how about some legal stuff.
Pick Your Formation.
You cannot receive money in exchange for shares if you are a Sole Trader. If you have thus far been operating in this way, therefore, you will need to incorporate your company before you can go any further. Incorporating your company creates an entity that is legally separate from yourself. It transforms your business into a Private Limited Company or a Public Company.
With these company structures, you are no longer personally liable for the business’ debts, the company is. As an incorporated entity, shareholder liability is limited to the amount shareholders have invested, the company itself can enter into contracts, own property, intellectual property and can borrow money in its own name.
A private limited company is usually the preferred option for startups seeking external investment in exchange for equity since this structure is the easiest to comply with. Each company is unique, however, and your company may be better suited to a different structure. The structure you choose to follow will have implications for the tax you pay and for the legal documentation you require so it is important to consult a solicitor for advice here.
Make sure that your business’ admin is up to date.
This one is common sense really, and VAT filings, your insurance filings, and your data protection policies. No investor will give you money until they have gone over your company with a fine tooth comb. They will examine your company accounts and budgets, and your legal documentation. All of your contracts – internal and external – will be scrutinised, as will your schedule of Intellectual Property, your property schedules and/or leases, your tax and VAT filings, your insurance filings, and your data protection policies.
Essentially, they will want to know if your company is legally watertight. If they find the smallest chink in the armour, they might be scared off, so it is vital that you check all this before they get to it.
A great place to start is with a Startup Legal Session with Linkilaw. We will have a look at all the legal basics and see what we can spot.
Get Your Docs Straight
After the due diligence, you will need to begin preparing the investment documents. You will first need to prepare a Term Sheet. This is not actually a legally binding document, but it more of a preliminary to the main documents I will discuss in a moment. It sets out the terms on which your investor is going to give you funding, be that by taking equity in your company, a convertible note, or another arrangement. It will also detail the obligations on your side and the requirements you will have to meet.
This document can be prepared by either party, but it is important to have a solicitor working with you here, both to explain any legal terminology and to negotiate the best terms for your business.
Here is a list of some other documents you may need:
Investment Agreement – more common from Series A upwards, the Investment agreement is an extended Term Sheet, with all the provisions of the deal. It is similar to a shareholders’ agreement in many ways, except the parties are the business and investors, not all the shareholders.
Shareholder’s Agreement – this will detail the agreed terms of the term sheet in more detail. It will explain the rights and obligations of any shareholders and should explain what happens in the event of sale or departure.
Vesting Provisions – will protect the investor or other shareholders from one of the founders leaving the company. They will make the shares ‘vest’ in the shareholders over time.
Subscription Agreement – this agreement is the promise of your business to sell a certain number of shares to the investor at a certain price, and the agreement of the investor to pay that price.
Articles of Association – these articles govern the operation of the company once it has received the investment.
SEIS/EIS -The Enterprise Investment Scheme (EIS) and the Seed Enterprise Investment Scheme (SEIS) are government schemes to provide tax relief for investors investing in startups. They are designed to encourage investment in startups and are a useful tool for any small company.
Speak to a solicitor to find out if you qualify and, if so, to get them to help you out with it all. There are a lot of rules and red tape around these schemes but if you qualify, you will instantly be more attractive to investors.
Follow these steps and investment will be a breeze. As with all these things, there is a lot of compliance and due diligence to follow, however, it is all worth it. Just picture the celebration when your first investment comes through.
This article was written by Alexandra Isenegger, CEO, Linklaw.