Due to its limited availability, as an entrepreneur, you are probably doing a lot with little capital. But there will come a point when most bootstrappers need external capital to grow. Once you’ve found investors, you’ll need to negotiate and complete the investment deal. Those investors may have previous deal experience they can rely on whereas you may be navigating this path for the first time.
This article will give you an overview of the steps involved in an equity financing (i.e. the issue of new ordinary or preference shares to an investor). Most equity financings follow the same pattern, but your exact circumstances will shape the necessary actions by each party involved in your financing round. Familiarise yourself with the path to completion before you approach potential investors.
Note: this article does not address the steps involved when using other instruments such as convertible loan notes, SAFEs and KISSes. If you’d like to know more, FUND my business has articles on each of these instruments and comparing their features. Each of these instruments is also available without charge on ScaleUp’s Documents page.
Step 1: What are you asking for?
Your investors will want to know how much money you are raising, what is the value of your company and what structure will the investment take. These points will form the basis of your discussions with investors when negotiating the investment term sheet.
• How much you are raising: This is a balancing act. You may be tempted to avoid raising too much money at your current valuation given your belief that the company will be worth significantly more in the short to medium term. But fund raising is hard work that is time consuming and expensive, so you don’t want to have to do it too often.
• Company valuation: The higher the valuation you push for, the tougher the terms investors will seek so they can achieve their desired returns.
Step 2: Term Sheet
Time to put pen to paper. Negotiating the term sheet with your investors is a key part of the investment process. Although the term sheet summarises the key commercial terms of the investment, the overall value of the deal will be determined in agreeing its wording. Preparation is crucial. Familiarise yourself with founder-friendly terms that you should seek to include in your term sheet and those investor-friendly ones of which you should be wary. Choose a lawyer who has experience working with founders and can call an investor’s bluff when they insist that a term is “market”.
Step 3: Documentation
You have your term sheet but you can’t put your feet up just yet. Now you need the formal investment documents which are more detailed and legally binding. Typically, an investment deal will involve the instrument itself a share subscription agreement, shareholders’ agreement and a restated memorandum and articles of association. Many founders expect that this phase will be straightforward as they’ve already been through the term sheet negotiations. However, more often it is not simply a matter of asking the lawyers to copy/paste the drafting. Further negotiations are common on items that were left out of, or not agreed at, the term sheet phase and mechanical matters ensuring the parties’ intentions work in practice. Plan for this step to take at least a few weeks.
Step 4: Pre-completion and conditions precedent
Almost there. This step includes anything that needs to be done after signing the investment documents but before you receive the money from investors and complete the deal. The term sheet and investment documents will set out the conditions which must be satisfied before completion. The length of time between signing and completion and how many housekeeping matters need to be attended to will dictate the number of conditions. Some examples include:
• completion of any outstanding due diligence by the investors on your business;
• agreeing a business plan and/or a budget for the business with the investors;
• terms of employment agreements with key employees;
• implementing an employee share option plan, phantom share scheme or other similar arrangements;
• transfer of any intellectual property rights from the founders, employees, consultants and other third parties;
• conversion of any outstanding shareholder loans into shares in your company; and
• final board and/or shareholder approvals for each investor and for the company.
Once any documentation is in agreed form (e.g. shareholders’ agreement), we recommend sharing them with your investors so they can be signed (but left undated) in anticipation of completion. You may wish to provide your bank details, too, so that the investors can set up the bank transfers. Allow plenty of time before completion for the documentation to be signed by your investors and by your company (e.g. if board and/or shareholder approvals are needed).
Step 5: Completion
The company and the investors agree the day on which completion (also known as closing) occurs. This date is usually set out in investment documents or is linked to the satisfaction or waiver of all the conditions. For a straightforward equity investment, on completion the investors pay the share subscription amount to the company and the company issues shares to the investors. The parties also exchange the signed and dated original documentation (e.g. the shareholders’ agreement and restated memorandum and articles of association).
Step 6: We’ve completed. Now what?
After completion, there will be some housekeeping matters to attend to. For an equity investment, these include:
• updating the shareholders’ register of the company with the investors’ details; and
• submitting the relevant forms/portal notifications to update the companies’ registrar (e.g. ADGM Registration Authority).
What else do I need to know?
In some jurisdictions, the offering of securities (including shares) is a regulated activity meaning there are specific laws and regulations governing how offers may be made and to whom. Your lawyer will be able to advise you how to structure your investment rounds to comply with the relevant legislation, including whether any exemptions are available to you.
How do we ensure the process runs smoothly?
You or your lawyer should create a checklist of every document and action that is involved in each step of the capital raising process. The checklist can allocate responsibility between representatives from the company, the investors and your respective advisors and should be updated continuously to reflect the status.