Availability of funding is critical to the growth and success of startups. As founders are not always capable of providing capital for their business through its life cycle, it is crucial that they are knowledgeable about the various stages of raising capital, including their requirements and the legal considerations for each round, to ensure their legal and commercial preparedness.

This article identifies the various stages of fundraising and the requirements applicable to each stage.

Stages of fundraising

1. Pre-seed

This is the commencement of the lifecycle for the startup, where its product is undergoing development and testing. Investors at this stage typically include friends, family, and angel investors. It is a critical stage for investors because investment is based solely on what they believe to be the strength of the product and the core team as no traction has been gained to prove that the startup is investment-worthy.

Legal considerations and Documentation:

  • A founders' agreement should be drawn up at this stage. It is crucial for the founders to also determine the timelines and the procedure for their shares to vest.
  • The preferred nature of investment must also be determined – either through debt, equity, convertible note or a SAFE.
  • Intellectual Property (IP) protection is also crucial. Trademarks, designs and patents should be duly registered.
  • Knowledge and compliance with the regulatory requirements applicable to the sector in which the startup is doing business is also important.
  • An accurate and detailed capitalization table1 (cap table) as well as a pitch deck for a proper presentation which will arouse the interest of potential investors and assist them in making an informed decision.

2. Seed Round

At this stage, investors are interested in the startup's business which has gained some level of traction and market share. The most common investors at this stage are family and friends, angel investors, early venture capitalists, e.t.c.

Legal considerations and Documentations:

  • Investors at this stage, typically invest in the startup in exchange for equity which is negotiated based on the valuation of the business and which may be calculated with the use of various methodologies and subject to different factors.
  • It is also typical for investors to conduct due diligence on the business, its corporate structure and assets to ensure that the startup is generally compliant and investment-worthy.
  • Important agreements to be executed include an investor term sheet, a share purchase agreement, and a shareholders agreement.

3. Series Stage

At this stage, the business already has dedicated users and is generating steady revenue. There is no limit to how many funding rounds a business can go through. The common funding Series are however highlighted below:

Series A: This involves a stage where a startup does not only have a great business idea and model but a proven strategy for creating long-term profit.

Series B: This occurs at a stage where a startup is generating consistent revenue but requires additional funding to be able to scale to meet its growing market demand.

Series C and beyond: At this level, startups with strong financial performance seek expansion into new markets, develop new products, buy out businesses, or prepare for an initial public offer. The common investors at this stage include; accelerators, angel investors, venture capitalists, corporate venture capital funds e.t.c, who are eager to participate in this round.

Legal considerations and Documentation:

  • Similar to the Seed round, Series financing results in the investors receiving shares in the startup. In addition, term sheets, share purchase and shareholders agreements are also typical.

4. Initial Public Offering (IPO)

Once a company is large and stable enough, it may choose to make its shares available to the public. An IPO occurs when the startup's shares are offered up for public purchase for the first time. The IPO is used to generate funds and for further growth.

Legal Considerations and Documentation:

  • It is important to set up a team of professionals to assist with the IPO.
  • At this stage, the rules of the Securities and Exchange Commission in relation to an IPO will be applicable. The company needs to ascertain compliance with all the rules.
  • Some of the prerequisites to the registration of an IPO include; filing of the SEC form 6, extract of the board and shareholders resolutions authorizing the offer, copies of the startup's incorporation documents, signed copies of the startup's audited account for the preceding 5 (five) years, copies of the draft prospectus2, draft underwriting agreement, vending agreement, and other documents required under the SEC rules and regulations3.

Conclusion

While investing in startups poses a high degree of risk, it also presents potential opportunities for immense rewards. It is important that startups engage services of professionals including lawyers, accountants, and financial advisers at every stage of financing to ensure that the investments are adequately negotiated, and the rights and obligations of the parties are clearly expressed.

Footnotes

1. A capitalization table provides an analysis of the startup's percentage of ownership, equity dilution and value of equity in each round of investment by founders and investors.

2. This is a legal document designed to provide information and full details about an investment offering for sale to the public.

3. Securities and Exchange Commission; checklist for processing applications.

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.