You’ve hatched an idea, formed a team and now you’re ready to raise private capital to jump start your new company. One of the keys to success is understanding the general process a startup will go through as it continues to grow and expand its operations. Below you’ll find an overview of the three stages… Read More
You’ve hatched an idea, formed a team and now you’re ready to raise private capital to jump start your new company. One of the keys to success is understanding the general process a startup will go through as it continues to grow and expand its operations. Below you’ll find an overview of the three stages we see most of our startups go through on their way to raising multiple rounds of capital.
A seed investment in a startup is usually between $100,000 and $1m with the primary investors being friends and family, as well as angel investors. At this stage, the company has little more than a speculative business plan and therefore is primarily selling the founders past experience, vision and long-term plan to those within their network who believe in the talents of the team.
With little operating capital, startups are looking to keep the transaction as cost effective as possible by using instruments such as convertible notes, SAFE and KISS agreements. These are all instruments that will convert to equity at a later date but do not give the holder actual ownership in the company until they do. However, don’t be fooled into think this is not a sale of a “security”, it is, and startups must be compliant at both the state and federal level when closing out this type of transaction.
This is the stage in which the startup actually begins its operations and is looking to raise capital to expand and continue development of its product or service. This is often the startup’s first engagement with an institutional investor (e.g. venture capitalist), and the amount sought is between $1-3m.
At this juncture, a smart startup is looking for more than just cash. No doubt, the capital is needed to fund its operations, but a savvy startup is also looking to form a relationship with an institutional investor to grant access to experts in their field who can advise on financial, strategic and operational issues, and can help lead a growth stage round down the line.
For early stage financing a startup will often sell “preferred stock”, and the investors who invested in the seed stage will convert their convertible instrument into equity during this round. This round will often cost two to four times as much in legal and accounting as the seed stage but is hopefully offset by the much larger raise.
The purpose of this round of financing is to expand the product or service to new markets, develop a new line, ramp up the team to scale, or even consider acquiring another startup/small business. While often turning a profit, or trending in that direction, the startup is often incapable of borrowing the funds it needs from a bank as they continue to look for a capital raise through another private placement round of financing.
Like the early stage, the investors tend to be large institutional investors, and the offer is for preferred Series B stock. However, unlike the early stage, the growth stage is often complicated by more complex financials and a greater number of shareholders and investors to consider. Additionally, with a longer operating history, the growth stage company is often viewed as less risky by investors.
Unlike seed or early stage startups, a growth stage company will go through an extensive due diligence process as the new investors investigate and kick the tires on the company. A lawyer familiar with the company who assisted with the first two rounds can typically keep the costs of the growth stage in the same ball park as the early stage round, however, because the overall structure has become more complicated it’s not abnormal for the round to exceed what it costs to complete the early stage round.
Having a sense of the process can aid in your discussions with prospective strategic partners, and investors. If you’re considering raising capital for your venture (big or small) please reach out to carry the conversation forward. You can contact us at email@example.com, or at (415) 633-6841.
Disclaimer: This article discusses general legal issues and developments. Such materials are for informational purposes only and may not reflect the most current law in your jurisdiction. These informational materials are not intended, and should not be taken, as legal or tax advice on any particular set of facts or circumstances. No reader should act or refrain from acting on the basis of any information presented herein without seeking the advice of counsel in the relevant jurisdiction. Bend Law Group, PC expressly disclaims all liability in respect of any actions taken or not taken based on any contents of this article.