Startup Fundraising: Raising Your Seed Round
So your company is set up, the plans are made and targets agreed on. All you need now is for the investment to take off so you can rent your office space, purchase equipment, and hire future staff.
One of the major hurdles that start-up business owners first face involves financing their start-up and keeping investors keen on their plans. This is known as Seed Funding and it is the earliest phase of funding for a business which can reach up to two million pounds.
Although gathering initial capital may seem like an impossible task there are a number of steps you can take to keep your investors hooked.
Stage 1: Company Incorporation
The first stage in attracting investors involves creating an incorporated business. This essentially confirms that your company legally exists and provides investors with numerous advantages.
The benefits of incorporating your company for investors include limited liability, which shields their assets in case of company liquidation. Secondly, it ensures that the investors’ assets can continue to be used if the owner or founder of the company decides to leave by providing what is known as perpetual existence.
Thinking from an investor’s point of view in a scenario in which nine out of ten start-ups could potentially fail they need to know that they can seek protection and minimise their loss. For this reason creating your company incorporated is the first step to facilitating investments.
Stage 2: Non-Binding Agreements
Non-binding agreements are crucial and sometimes overlooked steps in ensuring that the final binding document is signed by all parties. These documents provide the foundations of creating a final binding agreement between you and your investors.
Letter of intent
The letter of intent is the first place in which the investor’s interest in the company is expressed and the proposed deal is outlined. This documents can clarify the terms of the agreement before they are made final and can resolve disagreements. Furthermore, two essential clauses that can be included are
- Inclusivity: This protects the investors by knowing that your startup is not searching for better deals from other investors
- Confidentiality: this can prove crucial in maintaining the businesses scopes private.
A term sheet is a detailed agreement of the letter of intent and can serve as a draft of the final binding document. This piece can further clarify the understanding of the parties bargaining positions.
Stage 3: The Shareholders Agreement
The shareholder’s agreement is the final binding document you will create that will list out the shareholder’s and address their rights and obligations. This document is essential in making sure that there is a common understanding between everyone.
So how can a shareholders agreement benefit your startup?
- The terms of vesting
The Terms of Vesting can be a crucial tool in ensuring long-term sustainable investments. You have the ability to give an investor shares of your company over a period of time. Say for example, that an investor is willing to buy off 15% of your business but you are not sure if he will sell the shares as soon as it’s convenient to him. In order to safeguard the interests of your company, you can choose to give him 5% over a period of three years, ensuring that he doesn’t invest for short-term profit.
2. Deciding what happens when people leave
Thanks to clauses in the shareholder’s agreement you can decide what happens to people when they leave based on whether you deem them to have left under ‘good’ or a ‘bad’ conditions. In the shareholder’s agreement you can spell out what is required for them to do when they leave:
a) They can leave and keep all their shares
b) They can sell their shares at a market value
c) They have to sell their shares at a nominal value.
So depending on how you want to structure your business you could choose to force bad leavers to sell their shares at nominal value and good leavers to keep theirs. However, some business owners prefer to still not have empty shares handed to people who have left, so you could consider a good leaver selling his shares at a market value.
3. Future amendments
Further down the line, you might want to change your terms of investing or owning by, for example, issuing new shares. To issue new shares or change your company usually all is discussed in a board meeting. The next requirements are completing a ‘return of allotment of shares’ via an SH01 form. It is important to remember that to make any change you need to ensure that all has been written down and that there is proof in writing of all boards resolutions.
Stage 4: Enterprise Investment Schemes (EIS) And Seed Enterprise Investment Schemes (SEIS)
As well as the steps you can take to facilitate investing the UK government provides a number of incentives for investors to buy shares in start-ups. The Enterprise Investment Scheme (EIS) and Seed Enterprise Investment Scheme (SEIS) are aimed to encourage entrepreneurship by offering some of the most attractive tax reliefs available.
Enterprise Investment Schemes (EIS)
This scheme was introduced to encourage investment in smaller higher-risk trading companies. The investment can reach one million and the investor will benefit from up to 30% of income tax relief but no capital gains relief. Furthermore, it provides investors with a loss relief in which case if the shares end up being disposed of at a loss then the investor can elect that amount of loss at less income tax given.
Seed Enterprise Investment Schemes (SEIS)
With this scheme, an investor can give up to 150 thousand and is eligible for 50% tax relief and 50% capital gains relief. Generally, it aims to attract seed investment in the earlier stage of companies and by nature are more risky investments.
Stage 5: Long-Term Sustainable Investments And Future Amendments
Hopefully, the initial non-binding agreements will provide a foundation of consensus which will help you finalise the shareholder’s agreement. However, seed investments should not be solely seen as a means to get the company up and running. The final document binds the investors in a long-term manner and its details should not be overlooked.
Remember, when an investor buys into your company they are usually there to stay and if you later want major changes in your business it is in the shareholder’s agreement that you will be detailing how it can be done.
On what terms can an investor leave? What are the consequences for the business owners if they do leave? How much can they sell their share at?
These are all elements that need to be clarified at the seed investment stage and a detailed set up is essential to the future running of the business.