Legal expert reveals key considerations for startups when fundraising

A LEGAL expert has revealed the key points startups need to consider when raising funds.

Fast-growing law firm LegalVision says how to secure capital is one of the most common questions its commercial and startup lawyers are asked.

And it is keen to help put growing startups and businesses on the right path to success.

Sarah Aldersley from LegalVision said: “We have not only assisted hundreds of companies through the capital raising process, but we have also raised five rounds of funding ourselves since we launched in 2012.

“There are definitely some important aspects to consider from a legal point of view to make sure any funding will work best for your startup.”

One of the major drawbacks in raising capital is that it will dilute your influence – in other words you have to start answering to someone other than yourself.

Sarah said: “You need to make sure that taking on investors is the path you want to go down, but for many startups raising funds is key to success.

“We’d always encourage people to chat with other founders who have been through the experience to see what they can learn.

“If you use a co-working space, it’s highly likely there will be plenty of other startups on hand to give you some handy tips.

“One of the main questions founders should be asking themselves is, ‘Will I increase the value of my shareholding by taking on external investment?’.

“Being as it will dilute your shareholding, it needs to increase the value of your remaining stake to be worthwhile.”

There are a few different types of investor you can approach, depending on what stage your startup is at.

These range from family and friends right up to high-profile venture capital (VC) funds.

Sarah said: “Family and friends are great investors at the start of your journey as they believe in you and don’t expect too much in return for their backing.

“Meanwhile, angel investors – who are using their own cash – can really vary in their demands and approach. Most in the UK, however, are more conservative than those in the US, and definitely the ones you see in films and TV dramas!”

VC funds can vary widely in size and ethos, so it’s always vital to do your research before taking the plunge.

And Sarah says it’s important to consider what else investors can bring to your startup aside from simply cash. This can include opening doors to networks and key people for further funding rounds.

She added: “However, if they are a bad fit – for example if they talk about what they can do rather than doing it or want to have too much operational control – it can have an adverse effect and become a long-term problem.”

The two most common structures for an equity capital raise are an equity round or convertible notes.

Sarah said: “An equity round involves founders issuing shares in the startup to investors in exchange for cash.

“The main areas for discussion will be the company’s pre-money value and what type of shares an investor will receive, including their voting and liquidation rights. It’s important not to give away too much control.

“Convertible notes are a hybrid of debt and equity, and are often used between major funding rounds. The debt converts into equity on the occurrence of certain ‘triggers’, such as a priced round.”

Having the correct legal documentation in place is key to protecting your startup throughout the entire process, and onwards into the future.

Sarah revealed that the main pieces of paperwork you should be concerned with are a term sheet, subscription and shareholders agreement, your company’s articles of association and employment contracts for key employees.

She said: “The articles of association alongside your shareholders agreement are the most important documents as they set out the rights of and relationship between shareholders and directors.

“They will cover subjects such as issuing new shares, the sale of existing shares and investor rights including veto rights.

“A term sheet will generally come from an investor and list the key terms of their investment, such as valuation, rights attaching to their shares and any legal documents that need to be entered into.”

Sarah also pointed out that equity isn’t the only way to raise much-needed cash for expansion.

“You could also consider a venture debt round, using a structure known as a revenue loan,” she said.

“These are becoming increasingly popular and are a good option if you don’t want to dilute your equity and can’t access sufficient funds through traditional debt.

“Banks much prefer lending to profitable larger businesses, so if you are at the start of your journey this may be unlikely.

“Having a mixture of equity and debt can work well as it balances the needs of startups at different stages.”

LegalVision, which launched in the UK in June after 10 years of success in Australia and New Zealand, provides SME owners and startup founders with affordable, ongoing support through their innovative subscription-based membership.