An essential step to a start-up’s success is obtaining access to funds sufficient to facilitate growth. Many start-ups first look to the personal funds of the founders and then to friends and family for start-up capital. Although this may seem like the easiest approach, accepting money from friends and family presents potential pitfalls. Relationships will be at risk and family events and holidays may be a bit awkward.
Another potential source of financing is from “angel investors” or “angels.” Angels are generally high net worth individuals or groups of high net worth individuals. Typically, angels invest dollar amounts between $10,000 and $100,000 in companies that they believe exhibit a potential for high returns. Angel groups may invest up to $500,000 or more depending on the situation. The process of receiving funding from angels may be less involved than going the venture capital route, but significant due diligence on both sides is involved. Angels vary on their desired level of involvement with the company. Some are relatively “hands-off,” while others seek more involvement in the business.
Venture capital firms generally will seek a rate of return of 20 times their investment and will almost always require a seat on the board, a significant ownership percentage and the ability to appoint key personnel. When dealing with VCs, the client must understand that in exchange for the funds, some level of control will most likely be transferred away from the founders. That said, VCs are typically entrepreneurial and may provide significant expertise (in addition to capital) that many start-ups desperately need. The key is to select a VC that fits with the personality of the founders and the culture of the company. Pursuing venture funding involves extensive financial, business and legal due diligence. In addition, the legal agreements tend to be very complex.
Regardless of the financing path the client takes, it is important to have a solid business plan and a well-honed pitch. Investors will expect to see a professional, well-written business plan free of poor grammar and typos. In many cases it makes sense for the client to hire a professional writer to assist with the drafting of the business plan. It is also vital to make sure that the pro forma financials are integrated with the written portion of the plan—i.e., the words need to explain to the reader how the business will achieve the numbers.
It is also imperative that the clients comply with the securities laws when raising capital. Whenever investors are given stock, membership interests, profit interests or any form of equity (and sometimes debt), it is almost always treated as an issuance of securities and both state and federal securities laws need to be addressed. If you do not have a good grasp of securities laws, bring in a seasoned securities laws attorney to assist.
Steven J. Enwright is an attorney and partner at Lippitt O’Keefe, PLLC in Birmingham, MI. Steve advises clients in a wide variety of industries on business matters including general corporate counseling, mergers and acquisitions, start-up counseling, venture capital, corporate finance, technology licensing, and a variety of contract law matters.
Contact Steve at firstname.lastname@example.org