Introduction
It is often exciting to embark on a new business venture which aims at providing solutions and products that could potentially "change the world". However, in the course of developing and executing a new business idea, it becomes clear at some point that certain resources including human capital, funds etc. are essential for the venture to have a good chance at succeeding.
There is some dry powder out there that could be put to good use and the emergence of start-ups is at an all time high. With the new world we have all been trying to navigate since the beginning of the COVID-19 pandemic, opportunities abound for product developers, innovators, and start-ups to provide unique solutions to existing and novel problems. While it makes sense to leverage organic growth and bootstrap for as long as possible, there is a level of growth that can only be unlocked through the injection of external funds, and venture capital has proven to be a great resource for scaling promising business ventures.
Interestingly, venture capital has morphed over the years such that, in addition to the regular private equity firms, large corporations and governments have begun to participate in and even lead start-up focused investment initiatives. No doubt it is exciting to have access to a large pool of capital which could immensely contribute to the advancement of a business venture, as such this short piece focuses on providing some practical tips for start-ups as they explore financing opportunities.
- Understand the Proposed Terms in the Term Sheet
A term sheet is a high-level overview of a proposed deal. Often founders make the mistake of agreeing to the terms of a financing deal without fully understanding the implications. In negotiating a term sheet, founders should pay attention to the impact of the financing on the ownership structure, future financings, and business operations of the company. For instance, where a prospective investor demands to have pre-emptive rights and the same is agreed to, it means that the investor will have the right to notice of, and to participate in, subsequent financing rounds before other investors. Also, it is important to consider the cost of the financing and make sure the terms are generally good for the business in the short and long term.
- Use Confidentiality or Non-Disclosure Agreements
Certain business ideas thrive on their uniqueness and novelty. Where the continued success of a business idea is largely dependent on keeping the "secret sauce" away from the public for as long as possible, or when confidential or sensitive business information may be disclosed during the funding process, founders should strongly consider implementing a confidentiality or non-disclosure agreement prior to pitching to prospective investors.
- Maintain Accurate Corporate Records and Ensure Compliance with Regulatory Requirements
There is a tendency in the early stages for start-ups to be more focused on product development or attracting capital while inadvertently neglecting important legal and regulatory matters. In Alberta, for example, setting up a company doesn't end at incorporation; certain organizational documents such as by-laws, notice of directors etc., are necessary, and the company is also subject to certain periodic filing or reporting obligations. Also, it is important to be familiar with, and to meet any licencing, registration, and other regulatory requirements applicable to companies in the industry in which the start-up operates. Sophisticated investors would typically refrain from doing business with a company that is offside the law or that is unable to provide proof of compliance with applicable laws.
- Explore Both Debt and Equity Financing Options
Several factors are considered when structuring a financing deal, however while pitching to investors for funding, founders should be aware of the possibility of options other than equity financing. While equity financing in the form of the issuance of common shares and/or preferred shares is most common with venture capital deals, debt financing might be more appropriate in certain situations and the same should be explored for the benefit of the business. Hence, obtaining professional advice in structuring deals is highly recommended.
- Protect your Intellectual Property
A major due diligence test that must be passed by any start-up before a sophisticated investor would likely agree to provide funding is adequate protection of the business' intellectual property. One way of protecting a start-up's intellectual property is to ensure that all employees and founders assign all intellectual property rights in their work product to the company through their employment contracts. All intellectual property that the founders may have registered in their names at the inception of the start-up should also be properly transferred to the company at the earliest possible time. Further, it is important to have at the least initiated applications for patent, trademark, and domain registrations as well as registration of other intellectual property assets that are particularly relevant to the business early on to avoid losing out on financing opportunities.
Conclusion
While venture capital is not scarce, attracting it on reasonable terms requires work and strategic positioning. Founders are encouraged to do their due diligence and ensure they always have their ducks in a row to get access to the capital they might need at each stage of growth. It goes without saying that funding a start-up is significantly transactional and the onus lies on founders to ensure they have what it takes to maximize the opportunities available to them.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.
