Financing Your Company: Six Key Issues from a Lawyer’s Perspective
By David Peteler
Early stage businesses need financing to grow and succeed. Depending on your stage of development, you may be looking for “friends and family” financing, an Angel round, or a Series A round. While these different types of investors have their own investment requirements, once investors are interested in your company, they will want to do due diligence on at least these six basic items.
- Investment Proposition. How much of the company will the investor get for their investment? A pro-forma fully-diluted post-money cap table will show this, i.e. a cap table that shows all of the issued stock, options, warrants, and convertible securities; as well as the new stock to be issued in the financing. The pro-forma should assume that all authorized options and warrants are exercised, and all convertible securities are converted. It should also show how much money is being raised, and what the equity percentages will be after the new money has been raised. The pro-forma financial statement also shows investors that the founders have gone through the crucial process of allocating the initial equity.
- Basic Corporate Structure In Place. Investors want to be sure they’re investing in a company that is set up properly from a legal point of view, so they are confident that they are getting the stock (or other investment instrument) they think they are buying. They will want to see an existing entity (likely a Delaware corporation), with the basic corporate documentation in place.
- Commitment of The Team. Investors want to know your team is committed. Investors will want the founders and key people to sign employment or consulting contracts with stock vesting provisions, rights of first refusal, drag-along rights, and other rights. They will want team members to sign non-disclosure and IP assignment agreements. These agreements are designed to be sure the critical team members stay in place until the business has been developed to the expected level.
- Intellectual Property Protection. IP protection is important to investors, especially if the IP is unique or crucial to the company’s success. Take steps to protect it before you take investment money.
- Plan For Your Exit Strategy. Founders should design their businesses with the exit in mind, for their own purposes. Investors will want to know the exit strategy, so they know how and when to expect to monetize their investment. A startup seeking Series A investment should have a well-planned and well-articulated exit strategy. An early stage company should not be tied prematurely to a specific exit strategy, but should have a basic plan and some options in mind. The exit strategy will determine important decisions along the way, so it is not just a goal, but an integral part of the journey of the company.
- Term Sheet and Investment Documents. After the first few meetings, a serious investor will want to see, or will propose, a term sheet. Once the terms are agreed, the investors will request, or propose their own form, of investment documents. These steps show that the company is knowledgeable and realistic about the financing, and that the goals of the investor match the goals of the company. The investment documents will include a stock purchase agreement (or other type of investment agreement). Depending on the company and investment, there may be several other important investment documents. The details of these documents are critical to the investment, and potentially to the success of your company. They may also be critical to your position as founders in the company.
Founders will want to be prepared for each of these topics.