Earlier this year, the team at LegalVision gave us some helpful tips on the legal basics of starting a new business.
Over the coming weeks, we’ll look at legal matters that can arise for a new business once it’s up and running.
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Here, Lachlan McKnight, chief executive of LegalVision, looks at funding options.
Raising capital for a start-up can be difficult, particularly in the current economic environment. Many entrepreneurs are forced to resort to bootstrapping due to a lack of funding. This can lead to stunted growth and missed opportunities. This article sets out some options to consider when you’re looking to raise capital.
What do you need it for?
There are two threshold issues to consider before you raise capital:
- what do you need it for?
- what type of investor are you looking for?
Start-ups raise capital for many reasons, either during the launch phase (to help them start it) or while they’re operating. For example, do you need capital to fund initial expenditures such as salaries and marketing costs before your business starts generating revenue or do you need it to acquire inventory, increase your marketing budget or take on more staff as the start-up grows.
The type of capital you can raise will depend on the phase you’re in. If you’re an early stage start-up you will need to give away equity (generally through common stock or a convertible note) in order to raise the required capital. An established start-up with significant revenue flows will possibly be able to raise debt (and thus avoid giving away equity), although a series B or C equity investment is also often used.
What type of investor are you looking for?
You can raise capital from a range of sources, including existing shareholders, friends and family, professional or sophisticated investors, angel investors, venture capitalists and of course banks.
Once you’ve decided on the type of investor that you are looking for you should make a list of possible targets and speak to people who may be able to assist you in approaching these targets.
What are the options?
You can finance a start-up from any of the following, although the options available will of course depend on your size, revenues, profitability and the type of assets your start-up owns:
1. Yourself – the first port of call when looking to raise capital should be yourself. If you believe in your business it makes sense for you to have skin in the game – it also means you’ll be giving away less equity!
2. Borrow – draw down on the equity you have in any property you own, max out your credit cards and try to organise personal loans to give you some cash. Again, this type of borrowing will decrease the amount of equity you’ll have to give away, but make sure you don’t place yourself in a financially unviable position.
3. Family and friends – these people may not require a business plan, revenues and growth to invest. They know you and believe in what you do, so they will invest in your idea and trust you to make it work.
4. Sweat equity – bring new people on board who have the skills your business requires to make it successful. Rather than paying these people a salary, which your business probably cannot afford to do, you can agree that they will work for free in exchange for a stake in the business. This should incentivise them, the harder they work the more likely that the business will be successful and they will share in that success.
5. Angel investors and venture capital (VC) – wealthy individuals (i.e. angel investors) and venture capital firms invest in start-ups that have potentially high rates of return in return for a stake in the business. They may have the skills to assist you in helping your business succeed or make a passive investment, trusting you to make your business succeed.
6. Government grants and programs – there are a range of government grants and funding programs available to small business. Generally, such grants and funding programs are subject to qualification criteria.
Raising capital is a necessary step for many businesses. You should carefully consider the various sources of capital to work out what suits your business. If you do choose to bring on outside investors, make sure that your shareholders’ agreement is drafted in a way which protects you and your shareholding. Don’t lose control of your business because of poorly drafted legal documentation!