Common Legal Mistakes Startup Founders Make While Seeking Investment Funding
Seeking investment funding is not easy but it’s also a crucial way to get the capital you need to run and grow your businesses. However, there tends to be a number of common legal mistakes startup founders make while seeking investment funding that derails their efforts and can potentially destroy what they worked hard to build.
So in this post, we’re revealing what these mistakes are so you don’t need to make them.
1. Advertising To/And Or Soliciting Investors
It is illegal for startup founders to advertise to investors or solicit them for money. It’s really crucial that founders understand this distinction so they avoid making this mistake because unfortunately, in the eyes of the law, ignorance of the law is not an acceptable defence.
Advertising refers to any offline or online ad that asks for money from potential investors for their startup. Solicitation refers to asking for money via email, snail mail, or some other form of communication. The only times when solicitation is legally allowed is when there is already evidence of a strong ‘pre-existing relationship’ between both parties.
The bottom line is don’t advertise anywhere that your company is selling stock or ask anyone to buy stocks unless there is already a pre-existing relationship established.
2. Selling To Risky Investors
Some founders can be so eager to get investment capital that they jump the gun and simply take money from any investor offering it. It’s understandable considering they want to get their business off the ground but it’s not a good idea.
The safest way is to ensure you’re selling to experienced investors. Experienced investors are considered to be financially strong investors who have a high net worth or a significant amount of assets behind them to justify them being a safe investor.
You can read more about what constitutes an experienced investor here.
3. Using Unregistered Brokers
Be wary of someone who claims to be a broker who can sell or buy shares on behalf of your company but who actually isn’t registered. If you use an unregistered broker for these transactions then you’re breaking the law.
Use the Financial Services Register to find broker-dealers and firms registered with the FCA and PRA.
4. Not Investigating The Investor
Too many startup founders make the mistake of accepting capital from investors without first investigating who they’re accepting money from. When you’re accepting funding from investors, you need to remember that it now means they’ll be tied to your company for a specific period of time and the investment also grants them certain rights and responsibilities within your company.
Here are a few things to ask yourself before accepting money from an investor:
- What is their motivation for investing?
- What kind of person are they?
- Do they have good references?
- Will the investor add value beyond simply providing capital?
5. Issuing Preferred Stock
Too many startups make the mistake of issuing preferred stock and therefore equity, in their company when they’re not in a position to do so. Unless your startup is raising funding of £500,000 or more then you shouldn’t be issuing preferred stock to investors.
Instead, issue convertible notes to seed investors and then use that capital from them to convert into equity during the Series A financing round. Following this approach will keep the investments simple from a legal and financing perspective. If the investor insists on preferred stock, instead make a concession and issue common stock, which is still less complicated than preferred stock.
Avoid these common mistakes while seeking investment funding and you’ll avoid running into unnecessary legal issues. Legal issues are always a common problem for startup founders when seeking investment so we’d like to make it easier and less stressful for you.
Book a free Startup Legal Session and speak with a Linkilaw legal expert about legal pitfalls you need to be aware of while seeking investment funding. We’ll also tell you specifically what you need to do legally to ensure that your startup is well positioned to attract quality investors.
Book your session immediately below.