Growing startups often reach a point at which fundraising is either necessary to continue the growth of the business, or appealing for other reasons. If you are considering taking on investment funds for your startup, there are several basic considerations you should keep in mind. This post covers two aspects that may often be overlooked by founders, causing potentially significant issues for your business and fundraising in later stages.
First, as discussed in a previous blog post, when a startup is raising money, it is almost certainly selling securities, which is a complex process under both federal and state laws. When selling securities, almost all small businesses will want to find an "exemption" under the relevant securities laws, which allows the business to sell such securities legally, and without undergoing a public offering and the complexities that follow.
While there are several exemptions under which a business can legally sell private securities, the most common exemptions used by emerging businesses include a restriction against general solicitation. In simple terms, this can be thought of as a restriction against public advertising in regard to your fundraising efforts. Whether a certain advertisement or solicitation falls under the category of general solicitation can be a very fact-specific inquiry, and speaking about your business in general does not necessarily mean that you are soliciting for fundraising purposes.
However, if you have any sort of public advertisement planned, particularly in which you reference your fundraising efforts or present specifics about your financial situation, it may be prudent to speak with an advisor to understand whether you could be risking losing certain exemptions, which could make fundraising more complicated going forward. Particularly in the age of social media, and the interest local media may have in your startup, founders should be cautious before making certain information public.
A second consideration for early stage fundraising is ensuring that you are appropriately documenting all investments and loans made to your company. Many startups may be tempted to accept perhaps a small amount of money from a friend or family member, without clear terms set forth in regard to what that money represents. Is it a traditional loan, with an interest rate and due date? Is it a loan that converts into equity upon a certain occurrence? If it can turn into equity, at what rate will it be converted? Will the person supplying the funds be purely an investor, or will they have an active role within the company? If the latter, should you consider documents regarding intellectual property in regard to the work and advice provided to the company? Can you even accept funds from this person if he or she is not an accredited investor?
This is far from a full list of considerations, but provides some context for why even early investment dollars should be property documented. Undocumented funds, or documents that are ambiguous about the meaning of the funds, may create a barrier in later investment rounds. Even worse, improperly documented funds could mean that an investor later attempts to claim a larger piece of your company than you intended.
If you’re a startup or growth company seeking outside capital from investors, Gutwein Law can help guide you through all aspects of the securities selling process. If you’re ready to get the conversation started, call us at 765.423.7900 or fill out the form on our website.