Ready to raise capital?
For any startup, financing is a key piece of the equation. And as some people will tell you, the answer to all your questions is money.
The good news is there are multiple ways to secure the seed capital you will need to grow your startup into a successful business venture. Here are several options to consider for raising capital:
Straight Equity
In this scenario, you sell a portion of your company to an investor. You come up with economic terms and identify what rights the investor will have. The investor is now a part owner in your LLC or a shareholder in your corporation. The rights of the investor can vary, and may include rights of first refusal, preemptive rights that protect how much of the company an investor owns in the event you sell additional portions of your company to new investors, board representation, financial report delivery, indemnification, dividends, coverage of expenses and more.
Straight Debt
One way to get money is to ask for it. Loans allow you to get the capital you need when you need it – upfront. Then, an agreement sets the parameters for paying that specified amount of money back – either on demand or by a certain date. The investor retains a “note” for that debt, and in a straight debt setup, the note cannot be exchanged for any other type of asset.
One of the most important parameters related to straight debt is interest. The debt will likely be set up to bear interest at regular, predetermined intervals (e.g. monthly). Investors or financial institutions that provide the loan may receive regular interest payments. Once the loan has fully matured, the company will need to pay back the principal amount of debt back to the investor or institution. Straight debt is, as its name implies, pretty straightforward.
Convertible Debt
Debentures, bonds, and notes can all be set up as convertible loans. Instead of just returning the principal back to the investor, either over time or at specific events, these loans convert into equity. For example, you take a loan, and if you raise $1M, your debt will convert into equity for the investor. An investor loans you the money today, and if you actually succeed, it’ll convert into equity for that investor, potentially giving them special perks for being there from the beginning.
A convertible loan might provide the option to buy into the next round of financing at a discount. With seed financing, the loan can convert into shares of preferred stock upon the closing of a Series A financing. A potential selling point for recruiting investors, a convertible loan option avoids interest rate issues and can position the investor to take advantage of increased returns. Being convertible allows the investor to trade the loan for stock at a later date, without a price per share having to be determined at the initial time of investment.
Loans with Warrants
A different take on the loan and debt path, loans with warrants present investors with the option to buy stock in your company at a later date. This middle ground option between straight debt and convertible debt doesn’t give investors an immediate ownership position in your company. Unlike convertible debt, having a warrant establishes a specific price per share upfront – at the time of the initial investment. If the investor chooses to act on the warrant associated with the loan within a designated time period, then they will own a part of the company.
Simple Agreement for Future Equity (SAFEs)
It’s not debt, it’s not equity. It’s a contractual right that doesn’t touch your balance sheet (off-sheet financing). From a drafting standpoint, it’s not that difficult – thus the “simple” part.
Under a SAFE, the investor puts money into the company in exchange for the right to receive an equity stake in the future. While common stock in a company entitles the holder to certain rights under state and federal law, SAFEs do not represent an equity stake in the company. The SAFE only provides for a future equity stake, and only if a triggering event occurs, such as additional rounds of financing or a sale of the company.
On the plus side, it avoids any valuation issues for the business as it stands today. SAFEs can serve as a flexible document with fewer terms to negotiate, do not have expiration or maturity dates, and can save money in legal fees. For investors, the downside is that there is no guarantee the identified “triggering events” will actually occur. As a result, the investor may lose all of the money invested.
Forms like these from YCombinator are a great starting point, but make sure you get expert advice to customize for your situation. One important negotiating point will likely be the valuation cap, and if founders sell multiple SAFEs, it’s important to understand how much that dilutes the value percentage for each investor. Down the road, SAFEs lead to investors with minimum conversion rates and with flexible time parameters.
Are You Ready?
When it comes to structures, documents and negotiations, Nemphos Braue is experienced in supporting entrepreneurs at every level. From purchase agreements to warrants and SAFEs, expert legal advice when raising capital is critical for setting up your startup for success.
Contact Nemphos Braue to move ahead and grow your business.