CAPITAL RAISING & LEGAL CONSIDERATIONS
Most founders understand that capital raising is a core aspect for growing a business or expanding into new markets. The capital raise process, however, can seem exhausting and overwhelming.
This guide is designed to provide you with the basic tools you need for understanding how to approach the mechanics of the capital raise process, from preparation to post-closing, with confidence.
As a note, this guide applies to various corporate forms, including Corporations (INC) and Limited Liability Companies (LLC). However, the terminology used throughout is specific to Corporations.
ONE: HOW TO PREPARE
TWO: THE CAPITAL RAISE PROCESS
THREE: AVOIDING COMMON PITFALLS
ONE: IS YOUR COMPANY PREPARED?
What does it take to hit the ground running for raising capital?
Proper preparation, documentation, and organization.
1. FOUNDATIONAL MATTERS
- a. Is the company’s governance documentation professionally explicitly prepared for the company?
- b. Has the company properly followed the mandates outlined in its certificate/articles of in corporation?
- c. Does the company have bylaws that properly reflect its governance structure?
- d. Have the bylaws been appropriately followed?
- e. Does the company have a shareholders agreement in place that properly reflects the relationship among the shareholders?
- f. Does the company have the proper documentation for the ownership, leasing, or licensing of its assets?
- g. Has the company conducted meetings of the directors and the shareholders in accordance with its governance documents and applicable law?
- g (ii). Has the company duly recorded minutes of the meetings or written resolutions reflecting its key decisions?
2. AGREEMENTS WITH PERSONNEL
- a. Does the company have appropriate and thorough employment agreements with its W2 employees?
- b. Does the company have appropriate and thorough contractor agreements with its independent contractors?
- c. Does the company have appropriate and thorough advisor agreements with its strategic advisors?
- d. Do the agreements assign all past, present, and future intellectual property rights to the company?
- e. Do the agreements in place properly protect any company Confidential Information and Trade Secrets?
3. CLEAR OWNERSHIP STRUCTURE
- a. Does the company have a clearly constructed capitalization table supported by proper documentation?
- b. Does the company have duly executed grant agreements with all founders/sweat equity holders?
- c. Does the company have appropriate vesting schedules for founders/sweat equity holders?
- d. Did the company provide proper information regarding IRS 83b elections to founders/sweat equity holders? Did
the company receive documented proof of filing of the same?
- e. Does the company have duly executed investment agreements (or subscription agreements) with all existing investors?
- f. Is all company stock subject to the appropriate restrictions on share transfers?
- g. Has the company taken steps to ensure that the stock issued meets Qualified Small Business Stock (QSBS)
- h. Has the company avoided making any unregistered public offerings of its securities?
4. VENDOR & CUSTOMER CONTRACTS
- a. Are company contracts with third parties comprehensively and professionally made?
- b. Are company contracts with third parties comprehensive and professionally done?
- c. Does the company have a consistent legal process in place for on-boarding and off-boarding customers?
- c (ii). Do all customers sign all required contracts every time?
- d. Did the company execute agreements with all of its k ey vendors/suppliers with appropriate terms to its business?
5. INTELLECTUAL PROPERTY
- a. Did the company isolate the intellectual property that is critical to its business?
- b. Did the company implement a plan to secure its intellectual property? Is the company following the plan?
- c. Key pieces of intellectual property to consider may include:
- Trademarks: i.e., Names, Logos, Slogans
- Trade Secrets
- d. If the company is utilizing any intellectual property that belongs to a third party, are there intellectual property licensing agreements in place sufficient to meet the company’s business needs?
Our specialized attorneys can get your company up to speed on the key materials investors expect to see.
TWO: THE CAPITAL RAISE PROCESS
THREE: COMMON PITFALLS
It is not uncommon to run into challenges during the capital raise process that impact the timeline and outcome of a deal. Consider the tips below to prepare and navigate through some of the common pitfalls of the Capital Raise Process.
1. NOT PREPARING YOUR COMPANY PRIOR TO THE DEAL
See “Chapter One: How to Prepare” to ensure that you have taken the necessary steps for a smooth process.
2. RUSHING INTO A TERM SHEET
Do not sign a t erm sheet without first considering the details or consulting an attorney. It is exciting to find investors interested in your company, but not all term sheets are created equally or in your best interest.
3. FAILING TO UNDERSTAND THE CONSEQUENCES OF CAPITAL RAISE YOU ARE CONSIDERING
Make sure you have a solid understanding of the implications associated with your method of raising funds, including tax, control of the company, and decision-making issues.
4. FAILING TO MAINTAIN QUALIFIED SMALL BUSINESS STOCKS (QSBS)
Company stock that qualifies for QSBS status under the U.S. Tax Code can offer substantial tax savings to founders and investors upon its sale. Often, investors rely on the QSBS status of a company’s stock to decide whether or not to invest. Before any company stock is redeemed or transferred, seek advice from the company’s attorneys and accountants to ensure that QSBS status is not impacted.
5. GETTING IN BED WITH THE WRONG INVESTORS
Consider the following:
What is the purpose of your fundraising?
Do you need strategic investors to open doors?
Are the investors you are considering a good fit for your company?
Bringing on an investor to an early-stage company is akin to bringing on another partner. Therefore, make sure that the investor is someone you want to partner with.
6. USING THE WRONG INVESTMENT INSTRUMENT
Using a priced round instead of a convertible round (a per-share valuation instead of a convertible note) at too early of a stage can have major implications; including, outsized control for those early investors and possible impacts on the sizes of future rounds. Each investment instrument has its advantages and disadvantages, so consult with an advisor to make sure you’re heading in the right direction.
7. TAKING LESS OR MORE MONEY THAN YOU NEED BEFORE YOUR NEXT PROJECTED RAISE
Consider the valuation of your company now versus the potential valuation of your company in the future.
Does selling a larger part now make sense?
Will you be spending the raised funds wisely?
What resources do you need access to, and will the funds raised cover all of those costs?
If your company takes on less money than it requires, then you may be faced with the need to seek additional funding at an inopportune time, possibly at a reduced valuation- “a down round.”
If your company takes on more money than it requires, then you have sold more equity than you should have. This may impact the size of future funding rounds and the level of control maintained by the founders.
8. NOT HIRING THE RIGHT LAWYER
We do not include this pitfall simply because we are lawyers. Hiring the wrong lawyer can create unnecessary roadblocks for your deal.
Raising funds is a significant event for any business. Ensure that you choose an attorney or firm who communicates effectively and efficiently, can provide your deal with the attention it needs, and understands your industry’s unique challenges.