Raising capital is one of the most important and exciting steps your startup will take. It can also be one of the most complex. Before giving your first elevator pitch, it’s important to know the basics:
- Know the Structure. In order to accept an investment, your startup must first be properly structured for it. Organizational documents should be finalized and should address key issues such as ownership, control, distributions, and shareholder rights (among many others). Accounting systems and process should be in order, along with your startup’s financial records. Most importantly, your IP should be fully protected.
- Know the Rules (of Registration). Federal and state securities laws can be a potential minefield. Failure to comply can lead to severe financial penalties and can bar your startup from raising any capital in the future. Each time you issue securities (shares, convertible notices, etc.), they must be registered with both the SEC and the governing state securities division(s), unless an applicable registration exemption applies.
- Know the Rules (of Solicitation). Prior to the JOBS Act, it was illegal to “generally” advertise your securities offering. Startups were only allowed to raise capital through pre-existing contacts. That ban on general solicitation has been (partially) lifted, but be careful. Any general solicitation must still be made only to accredited investors (accredited investors are, typically, high-net-worth individuals or those with high annual incomes). In other words, you still can’t tweet out your offering terms at @TechweekKC.
- Know the Terms. Certain issues show up in nearly every financing transaction. It’s important to familiarize yourself with these issues – not only their meanings, but also what the “market” (standard) terms are for each. Important issues include: (i) vesting schedules and acceleration, (ii) anti-dilution rights, (iii) liquidation and transfer restrictions, (iv) participation and information rights, and (v) voting preferences and share classes.
- Know the Investor(s). Regardless of the investment structure, your investors will be your partners. Get to know them – due diligence is a two-way street. It’s important that your investors understand your business (as well as the risks) and have goals and expectations that directly align with your own.
Raising capital involves a number of complex legal issues. While it’s important to understand the basics, you should always consult with an experienced attorney to ensure that your company remains compliant throughout the process.