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Questions to ask - before considering raising capital in your startup

 Technology, automation and artificial intelligence (AI) seeks to cut out the very work that professional service advisors do.

By Law Squared

Raising capital can be the difference between an extended time on the sidelines and kick starting your company's growth trajectory. 

At its most basic level, a raise is essentially a bargain with someone outside of you business to reduce your total ownership and control in the business, in exchange for finds to grow your business potential (and value). These funds are typically used to access fresh talent or equipment which you need to take your company to the next level. 

Raising capital isn't a forgone conclusion; however there are several parts of the process which can be both time-consuming and challenging. The process can and should involve legal and accounting advice accompanied by the relevant transactions documentation. Law Squared is experienced at helping founders navigate these waters and have identified three key areas that you should turn your mind to before chasing the market's money.

1. Do I need to raise and why am I doing this?

The first step (and arguably the most important) is to be clear on why you need to pursue funding and whether you even need to do it. has your business got access to alternative funding arrangements which don't require you to give up ownership or control? Consider startup grants or private lending as a way of delaying (or avoiding) raising if possible.

In terms of the money to be raised, this is a compromise between how much money you want, and how much you really need. It's important to consider how many chances you may have to raise money - is this your one change to make the big time? On the flip-side, do you really want or need to dilute your business ownership to achieve that next level of success? You and your fellow co-founders are the only ones that can answer these questions. If you do decide to pursue the raise, you should consider the amount of capital you need for the next 12+ months, as well as the extra costs which accompany your expansion plan. 

Accountants can help with projections which will depend on your midterm revenue, R&D and other expenses including rent, staff and business equipment, which accompany the expansion. Besides being of great use to your business, investors (as mentioned below) will want to see these numbers. 

Consider also the timing of the raise. Going looking for potential investors when the company is in a trough of low growth and low funds put you at a distinct disadvantage. Raising after a good history of hitting milestones and with a bright future will make your business more attractive. They will assist in convincing investors that you are the best possible avenue for their money, and provides a clear link between their funds and your future growth. What successes can you show investors to demonstrate the strengths of the business and your team?

Identifying the amount of funds and the rights and obligations on both sides of the bargain is essential to working out from whom you will seek the funds. 

2. What are you going to get and on what conditions?

Angel Investors and venture capital funds will come to the table with different conditions. Identifying these needs and conditions should be a trigger for you to work out what kind of action you're willing to offer the would-be suitors. Do you want to offer a share of the business, or use a SAFE agreement or a convertible note to offer rights in the future value of the business?

Though should also be given to what else can be offered by the potential investor besides the money. Venture capital funds may offer different things depending on the contact involved - but are you looking for a local contact who is frequently available to guide you through a potentially tricky transition period? Or would an international investor, offering a high-profile network of contacts be prefereable as you expand your net? Maybe you don't want either - and would prefer to be left to your own devices by a silent investor who will leave you to sail your own ship?

This choice may largely be determined by how much in funds you require. Typically, any amount below $250,000 are best sought from angel investors, whereas larger raises will typically attract institutional investors, who may want more of a say in the business direction, if the business conditions are right. With venture capital, be cognisant that the investor will likely seek a seat on the board in recognition of their contribution, and this may affect any future business plans. 

3. How much of my business am I willing to give away to investors, in return for their investment?

The Venture Capital Handbook discusses several ways of pricing a business in its early stages. The crux of this discussion is that the method will depend on the circumstances in which you find yourself and how you tell that story (the numbers from your projection will help with this). 

The amount that you are willing to give up for substantial investment is dictated by:

  • The capitalisation of the investment at this moment (Consider how much money has already been invested in the business - if an investor is willing to invest $2.5 million for a business worth $5 million, you would expect to give up around half of your business)

  • The upside potential - Is there a small or large chance of the business paying off big time for the investor?

  • The downside potential - What are the chances that the investor loses all of their investment?

  • Potential to compromise - Are you prepared to offer another type of security for the investor? (Rights over business collateral, or changing the structure of the deal may encourage the investment despite the risks)

Ultimately, giving up a share in your business is a deeply personal decision. Your attitude towards risk, your belied in the business (and yourself), and the forward-looking projections of the business will all play a part. At the end of the day, a business is 'only worth what someone is prepared to pay for it' and this is generally an art as well as a science. Don't be afraid to walk away based on the feel of the deal. If it doesn't feel right, and negotiations turn nasty, this may be a reflection on how the future of the relationship will play out.

Overall, know your limitations and trust your intuition. 

If you are looking to raise capital for your startup, or simply want to know more about the process, Law Squared are running an event in conjunction with WeWork in Sydney in September - Raising Capital vs. Bootstrapping. If you would like to attend, please register here.

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At Law Squared, we partner with passionate entrepreneurs and businesses who need our technical help and expertise. We’d love to have a chat with you, so feel free to drop us an email hello@lawsquared.co


 

Law Squared

hello@lawsquared.co

+61 9008 5954

 
 

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