Raising capital for a start-up company can be nerve-wracking. Anyone who has ever bootstrapped a venture knows that looking for outside money lifts your endeavor an entirely new level. Many entrepreneurs have the urge to obtain money in any way they can. Resist that urge. It can really get you into big trouble. Below are 5 tips to assist you in the process:
It can really get you into big trouble. Below are 5 tips to assist you in the process:
Diligence Your Investors. Many start-ups get so excited about having found people to put faith (ie capital) into their idea that they forget to conduct due diligence on the guys and gals across the table. That’s the biggest mistake you can make. You will probably be married to them for a while—until the opportunity for an exit arises. So, investigate, ask around. Sit down with them and find out their motivation. Are they good guys or jerks? Will they contribute value-adds aside from cash, such as connections, technical expertise, business savy?
Comply With Securities Laws. Your start-up cannot offer or sell its securities unless they have been registered with the Securities Exchange Commission or the offering is exempt from registration. Failure to comply with the applicable securities laws could result in investors getting their money back, injunctive relief, fines, penalties and even criminal prosecution and spoil your chances of successful future rounds. There are many rules you have to follow in exempt private sales, so educate yourself or even better, hire competent counsel. This is not the time to be penny-wise, pound foolish.
Choose the Right Legal Structure. If you are going to seek seed and VC funding, do not set-up your business as a limited liability company (LLC) or any other type of entity that could be taxed as a partnership. Investors want to keep their personal taxes as simple as possible. In most cases this means forming C-Corp.
Button-Down the IP. Make sure that the company, not the individual shareholders/founders owns the intellectual property (IP). This means signing assignments for IP created pre-formation and confidentiality/invention agreements post-formation. Also watch out for anything developed by consultants/independent contractors.
Keep the Investment Terms Simple. If investors start requesting complex or out-of-the-ordinary-terms, be cautious, especially in early rounds. It is a sure-fire way of setting yourself up for trouble down the road. Staying in line with industry standards is a safe bet and also prevents painfully protracted (ie: expensive) negotiations.
Eckerle Law offers legal advice in a variety of transactional and regulatory matters and serves companies’ plenary business law needs. Its founder, Bettina Eckerle, practiced law at Debevoise & Plimpton and Wachtell, Lipton, Rosen & Katz, before serving as the General Counsel of two companies en route to IPO. Please visit the Eckerle Law website for more details. She is also the author of "The Ultimate Guide to the Advisers’ Act, A Practitioner’s Handbook" that is now available on Amazon.com.