Raising Equity Investment: What you need to know first

Raising equity investment in itself can be an arduous task, but quite often the real pain can be after the money has been received.

For many early stage businesses the need to finance costs prior to revenue being generated is essential. Very early stage startups adopt a range of bootstrapping techniques such as working from home or shared office spaces, earning a salary on another job to fund their time within the startup or bartering services with people with other skill sets, such as developers, designers or advisors. Ultimately, however, the Company will need a significant capital investment to be able to move beyond bootstrapping operations.  One of the simplest ways to do this, on paper at least, is by raising equity investment. This means the Company will sell shares in the business to angel investors and venture capitalists. The angels and VCs get a share in the business at a very early stage when the price is low and when the potential to earn a large return on their money is high. The business owners get, what at that stage, is a comparatively large amount of money in the bank to secure a runway sufficient enough for them to develop a product and launch to their market.

Almost all the startups we work with progress down this road as it’s a win-win situation, right? Well no, not quite, and we’ve encountered a number of startups that are surprised and more often bewildered about what responsibilities they have taken on when they sign acceptance of the money.

We’ve therefore summarised the key things a startup owner must consider before your start raising equity investment:

Investors will take a keen interest in your company

So an investor has placed a five to six figure sum of cash in your bank in exchange for a share of the business.  Understandably they’ll want to be kept abreast of how that money is spent.  Make sure that you proactively keep the investor up to date with weekly to monthly progress reports, whether that be by email or by phone call. Ignoring your investor is at best rude but more importantly could strain relations and reduce chances of taking on more money in the future. On the flip side if an investor is asking for too much information or calling you incessantly for an update, it could be indicative that they are risk averse and worried their investment will be lost. Make sure you manage an investor in this situation well by firmly, but politely, agreeing specific reporting periods to allow you to actually focus on the business without interruption. The investor doesn’t run the business after all, you do, but try to manage them and keep the relationship positive.

Investors can open doors for you

The best investor, if you have a choice of two sources of money, is the one with the domain experience. This means that they know your product sector and target market and can introduce you to potential new customers, suppliers or even key hires for your business.  If this is the case make sure you utilise their network to maximise any opportunities and ask them for advice on anything you’re unsure about.  The investor may ask to attend some of the early meetings with people they have introduced which can be fine as long as it clear in the meeting who is the executive responsible for running the business, i.e. you. Beware of some of the pitfalls though. I’ve experienced VC investors who took it upon themselves to meet potential customers on their own and even begin negotiating commercial terms and development timescales.  On other occasions I have had new staff forced on a business who simply weren’t the right fit, simply because an investor wanted them involved. Make sure that you accept their help where appropriate but have clear boundaries.

Manage the cash as if it were your own

When you own your own business, cash management is vitally important to ensure the business survives. After you take on equity funding, however, cash management becomes even more essential. Aside from the obvious governance responsibilities, you are now essentially spending other people’s money, and you must ensure it is being spent in line with the business plan you presented to get that money in the first place. Therefore ensure that budgets are closely controlled. Most importantly, though, ensure that the money spent is justification of what you’ve promised i.e. delivery of a product, finalising a new contract etc. What you don’t want to do is to take a huge salary for yourself or employ new people without prior approval, blow the money 6 months ahead of the forecasted schedule and have nothing to show for it at the end.  It’s also important to tell your investor any bad news as soon as you get it with regards to cash; businesses fail because they start looking for new investment too late so if the plan is behind schedule make sure you start making your investors aware as soon as possible to allow new cash to be secured and safeguard their original investment.

You must hold board meetings

All investors will issue terms and conditions under the initial term sheet and then will sign up to a shareholders agreement when the cash is committed.  This will mean you will have legal responsibilities to your shareholders, the most common of which is the need to hold regular board meetings. These meetings should be held regularly in line with the company’s Memorandum and Articles of Association and it is common for investors with a significant share to also request a place on the Board, or indeed make this a condition of their investment. Founders must therefore ensure they are familiar with their new responsibilities to the Company, Board and shareholders, and are comfortable with the additional governance duties they have signed up to.

Don’t get pushed out!

Whilst one of the attractions of being in charge of your own business is that you are accountable only to yourself, rather than a boss, in reality it is very rare for this to be case. You will always have customers, key suppliers and when you make the decision to take in investment, you now also directly report into your Board, as a Founding employee.  It often comes as a surprise to some startup founders that they can actually be removed from their own Company if they don’t perform or if they hold back key information from their Board of Directors, particularly if the news is bad and could affect the ongoing viability of the business model.  An investment usually requires the Founders to sign official service agreements with the Company, which is likely the first set of employment terms and conditions they will have been subject to in their business. Make sure you have these checked by legal representation to make sure that you are comfortable with any performance conditions and termination clauses.

In summary, if you are raising equity investment, it can be the kickstart a promising business needs to realise its potential. Shareholders can be provided with tremendous value and support outside of the funds they introduce. However, if you are unsure about any of these points you would be advised to take guidance from a solicitor before proceeding.  Nuvem9 Ltd has experience within its team of both sides of the equation, namely successfully raising a round and managing that through with investors, and also in assessing and committing funds to an investment as a shareholder. Please contact us in the contact form below if you would like to set up a free consultation on how we could assist you with your upcoming investment.

Niall McGinnity

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