Raising capital with friends and family

Raising Capital for Startups: Strategies for the early stages

You have a marketable idea and a plan in place, and need capital to get your wheels off the ground. In our experience, much of first round funding — referred to here as the seed round — often comes from friends and family. Here’s a few things you need to know about seed round funding:

  • Since startups are seen as relatively risky investments, traditional channels like bank loans are off the table
  • As the investors in the seed round are often inexperienced, and because sophisticated negotiations require time and money, funding structures need to be simple
  • Your investors must be accredited, a term that refers to meeting wealth or income requirements as set out by the SEC

Funding strategies for the first round

There are two common capital-raising structures we like that address the unique demands of seed round funding, mainly because there are few variable terms in the offering:

Convertible notes are a form of debt that can be converted into stock after the conditions set out in the agreement have been met. They carry a maturation date of 4-60 months. An offering includes a discount on the stock upon conversion. The investment is represented by debt that can be called if the notes are not converted, which appeals to investors as a measure of protection against risk.

Series Seed Preferred Stock is an agreement in which the investor accepts equity in the business. Founders may see this as an advantage, as it keeps debt off the books. Series Seed structure was originally developed to simplify the terms of offerings, but a trend has since emerged of investors negotiating the terms of Series Seed offerings. The result is convertible notes once again becoming common.

Why they work well

The simplicity of both structures comes from deferring the settling of more complicated terms to a later stage of the business, when a more experienced investor takes an interest in the startup. Simplified and standardized agreements allow founders and investors to reach common ground without delay and put the capital into action.

Beyond the seed round

Expect future rounds of funding, if needed, to be had from venture capital firms and angel investors. For Series A funding, startups will need to put together a clear explanation of how investors can expect long term growth and a high ROI. Series B offerings are meant to build off a healthy customer base, and can be seen as a point of graduation from startup to established business.

Companies with larger visions may find themselves moving into Series C and D funding, which are implemented to expand the scope of a company and/or move toward an IPO, and possibly an exit strategy for startup founders.

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Though startup founders may not immediately have the time and resources to start developing an exit plan, looking at this as part of the big picture is critical, as it will inform your business decisions throughout the life of your company.

What makes a business highly sellable? What are investors looking for? How can I valuate my holdings in a company? For answers to questions like these, check back to this blog, where we present information about navigating the growth and sale of businesses. To discuss how we can help grow and sell businesses of all sizes, click here to fill out our four step contact form.

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