Navigating your startup from being merely idea to being an investor-backed company is an exciting and daunting task. Early startup funding rounds differ substantially from later rounds: you are seeking funding to prove your idea, you don’t have a proven idea with which to seek funding.
The key to early startup funding lies in approaching each consecutive new step with a keen understanding of the unique requirements of that particular round, its purpose and structure, as well as the legal issues to keep in mind.
Friends & Family Funding Rounds
Every startup begins with only an idea. To develop and refine that idea, you might initially require very little funding, and you won’t have much more than idea with which to secure funding. Many founders obtain the startup funding for this initial phase by using their own savings, or incurring credit card debt, or by asking friends & family for the initial startup capital.
Friends & Family rounds can take the form of completely unstructured financial support. However, that is not advisable: it leads to conflict and misunderstanding about equity claims or repayment terms down the line. Regardless of how nascent your startup is, even friends & family rounds should ideally be formalized.
Friends & family startup funding rounds often take the form of equity subscriptions, unsecured loans, or convertible notes. Your startup might not be formally incorporated by now, and it won’t have a reliable valuation, so it is best to raise this initial startup capital without reference to company valuation.
Many startup founders don’t realize that even these early rounds of friends & family funding have to comply with state and federal securities laws. The friends/family that provide your initial startup capital do not have to be literal friends and family, but they must comply with the standards set out by state and federal laws when it comes to qualifying as accredited investors. If not, you could face penalties or even be forced to repurchase your stock at a later stage.
For the friends & family round, the important consideration from a securities law perspective is that there must be a close relationship between the investor and you or one of your co-founders. In other words, it must be an investor that you access through your personal network. You can’t advertise on billboards for friends & family funding.
The angel series, also sometimes called the seed series, is the first round of raising startup funding from a formal investor (or, more generally – from a third party, i.e. someone not necessarily accessed through your network).
Angel funding is used to determine the strategic goals and direction of the company: it funds your initial research into and refinement of your product and its potential market. This usually includes product identification and development, marketplace orientation, demographic targeting, and setting up a team.
This is a risky stage of fundraising: you do not have a proven business case yet. For this reason, angel funding is often raised from multiple angel investors, each contributing a relatively small share of the angel startup capital.
At this stage, it is usually still too early for reliable company valuations, and for that reason angel funding rounds are often structured as convertible notes or SAFEs, although it can be in the form of equity grants or loans. This will depend on your startup’s unique situation.
Series A Fundraising
Series A is the first round of startup funding that is targeted at getting funds to scale your business, not “start it up”. You will generally use this round of funds to expand and refine your product and develop your customer base. This means that Series A funding is typically much larger than angel funding, and that this round will generally be associated with equity grants – you should be at a point where company valuation is feasible.
Series A funding is associated with more strenuous legal, financial and commercial due diligence processes, and accordingly more involvement of legal representation (both from your side and the investors’). Equity grants during Series A funding is also typically associated with more onerous provisions such as anti-dilution terms.
Regardless of the size or structure of your fundraising rounds, you will have to comply with state and federal securities laws. This means that you are required to register the securities in question with the Securities and Exchange Commission (SEC), or to find an available exemption from registration. Almost all exemptions require that your investors are accredited investors, hence the importance of vetting your investors beforehand and keeping all investment rounds, regardless of how small, formally structured.
Contact One of Our Expert Securities Attorneys
At LawTrades, our startup attorneys have experience with all of the legal fundraising options that business owners need to understand so they can make informed and reasonable decisions. For companies who prefer to raise capital through equity, an experienced fundraising law attorney can help set up an equity financing raise. An attorney can also ensure that corporation is set up to raise money by selling shares of stock in the company. Regardless of the method of fundraising you choose, a skilled attorney can be very helpful in providing you with the fundraising services you need to make your capital raise a success.