Sorainen: Startup fundraising – how to do it right?
Legal firms help startups to prepare investment rounds and carry them out, advise strategic, angel and venture investors on choosing the right startups for investments and deal with investment-related legal documentation. Sometimes they also offer some pro-bono help ranging from templates to free legal advice - Sorainen hosts a monthly free legal clinic for startups in Tartu and in cooperation lawyers from other law firms have created standard templates for venture capital investors and accelerators which you can find HERE.
The winning team of the sTARTUp Day pitching competition will also win 5,000 euros worth of legal counseling from Sorainen.
Based on the startup lifecycle, the first investor in a startup is most likely the founder him-/herself. Then, if the idea is good enough, they might get their family and friends, accelerator or a business angel/crowdfunding platform on board. With these resources, most startups can create a prototype, develop and launch it. After launch, it’s time to celebrate startups' first revenues, focus on marketing and if necessary, hold seed capital fundraising. As the business grows, it may be time for venture capital fundraising as well.
Generally, the legal form of M&A (mergers and acquisitions) deal for regular businesses is SPA (share purchase agreement). However, with startups and fundraising, it’s very different. There are several possibilities, but the most common ones are an IA (investment agreement) or SSA (share subscription agreement).
The process of investment can take some time since a lot of things have to be addressed and checked. First things first, your lawyer will put together a term sheet and conduct an audit. A startup in question is checked on legal, financial and tax due diligence. Legal due diligence includes intellectual property matters, cap table, employment relations, and client/supply agreements.
Investment agreement vs shareholders agreement
If everything is fine after audits, drafting a proposal and negations take place. Investors agreement should cover the valuation of the company, amount of investment, class of shares (are they common or preferred), details of the investment procedure, warranties, specific indemnities and liability matters such as caps and disclosures.
The investment agreement is always signed, but sometimes a shareholder agreement is necessary as well. The shareholders' agreement includes veto rights, a board seat, anti-dilution provision, liquidation preference, preferential subscription rights, and share transfer regulations.
5 ways to invest
There are numerous ways to invest in a company. The most common way of doing this is through straight equity, which means investors get a share of the business at a predetermined valuation when they invest. With straight equity investments, one has to consider investment amount, valuation, number of shares they receive and warranties.
Another option is giving a loan. With this option loan amount, interest rate and repayment date have to be agreed on. The third way is to invest is through convertible instruments. This means the investor would be loaning money to a startup and instead of a return in the form of principal plus interest, the investor would receive equity in the company. In this case, it’s necessary to determine the investment amount, interest rate, conversion terms, and maturity date.
Sometimes a SAFE/KISS agreement is also made. SAFE (Simple Agreement for Future Equity) and KISS (Keep It Simple Securities) are both vehicles for early-stage and startup companies to obtain initial financing - avoiding long and expansive negotiation with investors
And finally, another way, which is not very common but still worth a mention is investing through ICO (initial coin offering). This investment method involves cryptocurrency: interested investors can buy into the offering and receive a new cryptocurrency token issued by the company. This method gives the investor no shareholder rights.
Issuing new shares
If a founder wants to dilute share capital or get more investors on board, the issuance of new shares is in order. Cap table is often used in startups to show ownership stakes in the business and has an overview of all percentages of ownership in the company as well as about equity after each investment round.
There are alternative options for a founder to consider while searching for investors. For example, you can find shareholders from your own employees. You can offer them some perks such as the right to acquire shares with a vesting period or with an agreed price. An alternative method is to give a convertible loan, but the valuation of this kind of a loan needs to be negotiated with qualified financing investors and the startup.