Legal Considerations for Startup Funding

Legal considerations to prepare your startup for investment

Congratulations! Your startup is coming to life and you’re looking to grow it by raising funds. Raising capital can be an exciting and daunting process – and securing it may be that step that takes you closer to where you want to be. You might have the perfect elevator pitch, but are you ready from a legal point of view? Here are some important legal factors to consider before (or as) you start raising capital.

Is issuing shares the best option?

Before you dive into the process of preparing your startup for issuing shares, it is worth considering the other ways of raising funds. Remember that when you offer equity in your company, you are diluting your ownership and control of the company. Alternatives include:

  • Startup grants
  • Loans 
  • Bootstrapping 
  • Revenue sharing

Once you’re sure about issuing shares, set boundaries for how much of the ownership you’re willing to offer in return for funds.

Factors investors take into account

No matter how exciting and revolutionary your startup idea is, there are certain legal hurdles which are crucial to securing investors. Make sure you have the answers to these questions and know what you can expect from investors.

  • Do you own your intellectual property: website / app / software code, patents, product design, logo, art, trademarked brand names?
  • Does the company have any liabilities? 
  • What is the current share structure of the company? (Tip: keep a capitalisation table (aka Cap Table)
  • Have you set aside an option pool?
  • Will you offer an Employee Share Scheme?
  • Will the investor work at the company?
  • Will the investor be on the company’s board? 

Business structure

If you’re currently operating as a sole trader or partnership, then the first thing you need to do is incorporate. Your startup needs to be structured as a company to raise funds.

If you see your future in the US, then consider whether it is worth setting up as a US company from out outset.

Who can I raise funds from and how much?

A private company can raise from existing shareholders, company employees, a subsidiary company and from the public (although there are limits on the amount, expertise requirements for the investor etc). 

It is crucial you get legal advice about who you can raise capital from and whether you need to provide disclosure documents and lodge them with ASIC (Australian Securities and Investment Commission). 

Another option is crowdfunding through a crowdfunding platform (Kickstarter, Indiegogo, Patreon etc). This also involves particular registration, reporting and disclosure documents. 

What are the different stages of funding?

  • Angel: A small round usually with the aim of getting a new company off the ground. Angels are typically either friends and family, or investors who want to get in from the ground up.
  • Pre-seed: Pre-seed funding is usually from the founders as well as family and friends. You have the advantage of knowing them and vice-versa. 
  • Seed funding: Seed funding opens the company up to investment from angels and venture capitalists. This stage is about bringing your idea to life and often involves product development, market research and potentially hiring key employees. 
    • Accelerator/ Incubator Program: An option at the seed funding stage is to work with an accelerator or incubator. These programs usually involve mentorship, training, office space, and funds in return for equity. 
  • Series A: Series A funding generally means the startup has gained some traction. By this point, investors will want to see the business’ financial details and plans for longterm profit. 
  • Series B, C, D: Later series funding means your startup has lifted off the ground and you’re looking to develop, hire more employees, expand into new markets and potentially develop more products. 

Legal arrangements on funding

There are different legal arrangements which can be set up to issue shares. At its simplest, you are looking at a Share Subscription Agreement or Share Subscription Letter and Shareholder’s Agreement. Although Shareholder’s Agreements are not compulsory, they provide security to the company and should detail dispute resolution methods and the dividend distribution policy.

Alternatively, you could use SAFE notes (A Simple Agreement For Future Equity). A SAFE note is a contractual agreement to issue future shares in exchange for funds at a trigger event (usually the end of a fundraising round – such as Series A). Another option is a Convertible Note. A Convertible Note is a loan made by an investor in a startup which also turns into equity at a trigger event. The key difference is a Convertible Note is set up as a loan and a SAFE note is a security (contractual right) which helps your startup to mitigate insolvency.

Each time shares are issued or transferred, the company records and ASIC register need to be updated. 

Conclusion

Your startup is taking off and getting additional funding to keep the ball rolling is very exciting. However, there are important legal factors to consider, including the dilution of ownership and different sale options.

If you need assistance preparing your startup for investment or with the investment process get in touch with us via the contact form or by calling 1300 337 997. 

About Brigid Nelmes

Brigid NelmesBrigid is a legal intern at OpenLegal, working with our legal content team. She is currently completing her Bachelor of Laws and Bachelor of Arts (International Studies) at the University of Technology Sydney. Her interests are in digital/privacy and startup law.