Raising Capital: The Ins and Outs of Late-Stage Funding from a Legal Expert

Your previous pitch focused on potential, but now that you’re in the late-stage financial arena, it’s time to focus on performance.

As the founder of an early-stage startup, you’ll be used to making key decisions to grow your business. At this point, it’s likely that your basic business structure is firmly in place: sales, marketing, fulfillment, and support. The uncertainty about the success of your business has diminished, but your capital needs have never been greater. Fortunately, the more stable your business becomes, the more financing options you will have available to you.

The question is, what is the best way to grow your business at this point? Do you need to go public to raise the necessary funds, or are there other opportunities to fund your ambition?

Sophie Mao, practice leader within LegalVision’s venture capital team, advises the legal and corporate governance perspective of these issues for clients on a daily basis. She recently shared her top considerations for anyone setting up late-stage funding at Startup Daily’s From Idea to Unicorn event series. Here’s what she wants you to focus on.

Before getting up

Determine the best way to structure the deal

“To start, one of the first considerations is how you’re actually going to fundraise and how you’re going to structure the deal,” Mao said. “So people often think of late-stage financings as rounds. However, it is still quite common for mature startups to bridge using SAFEs or convertible notes.

Price capital rounds

Price equity rounds can take a long time to trade, leaving you without sufficient liquidity. Sometimes they take so long that your company’s value has increased to the point that you have to renegotiate your share price again.

Convertible Notes

Instead of offering stock to investors, you offer a convertible note, which is basically a fixed-term loan to the company. At the end of the term, your investors can choose whether they prefer to get their principal back plus interest or if they prefer to have the loan converted into shares of your company.

SAFE BOXES

SAFE stands for “Simple Agreement for Future Equity”, and it is a form of convertible security. In exchange for their money, your investor receives the right to buy shares in a future round, subject to certain parameters defined in the SAFE.

While they each have their setbacks, convertible notes and SAFEs will both help you raise money faster, so they’re worth looking into.

Debt at risk

This is the other type of funding available in a late-stage funding round. Venture capital debt takes the form of a term loan, facility or income loan.

“Venture debt isn’t really an option for start-ups,” Mao said. “You wouldn’t have achieved the consistent cash flow required to demonstrate to a subprime lender that you can service the loan. But it might be a good option for a later-stage business because the higher interest rate and lender fees might still be cheaper than giving equity.

You also limit the initial dilution involved in completing a round.

There are three main types of risky debt structuring:

  1. term loan – it is similar to a traditional bank loan in that at the end of the fixed term, you must have repaid the principal and accrued interest in full.
  2. Revolving credit facility – it works like a credit card.
  3. income loan – a hybrid between debt and equity, rather than requiring fixed interest payments, repayments are tied to the borrower’s turnover.

Consider your number of shareholders

As your business grows, new financing solutions may mean you risk exceeding the 50 shareholder cap for private companies.

“Consider whether it is appropriate to put in place some structures to manage this number,” Mao advised. “[One example is] roll your small investors into a sort of bear trust structure, where the underlying investors still benefit from their shares, but there is only one corporate trustee on the company’s share register .

Protect the rights of your investors

It’s important to prioritize the rights of major investors and consider limiting the ability of minority shareholders to slow down or impede your ability to get things done.

“In the beginning, it might not have been very difficult to treat all investors equally when it comes to things like reporting requirements and pre-emption rights on future capital raisers,” noted Mao. “But as the number of investors increases, it could be a barrier in fact, and a heavy administrative burden compared to getting a deal done, if you have minority shareholders who are very slow or potentially just unresponsive. .”

Participation in the secondary sale

If there is strong investor interest and the round is oversubscribed, there may be an opportunity for third-party investors to purchase shares from existing shareholders.

“As a founder, this could be a very good opportunity for you to finally get some money off the table after working very hard and making a lot of sacrifices for a long time,” Mao said.

Typically, investors are willing to structure the deal to include a secondary element if it makes sense for the company and the founders.

Do the trick

Know your liquidation preferences

A liquidation preference is a clause in a contract that dictates who gets paid first if your business goes bankrupt.

“As you grow and do a few fundraisers, you might end up with several different classes of preferred stock,” Mao explained. “This means that one of the key terms to negotiate in a new cycle is whether the new preferred shares will rank pari passu or senior to the preferred shares of your existing investors.”

Many startups support equal ranking preferred stock as a principal because they like that investors are all treated equally. However, it will be about assessing the risk of bringing in your early stage investors when your startup was less stable, with early stage investor risk likely injecting more money.

“From a founder’s perspective, it might not be something you care too much about, because unfortunately if the company goes bankrupt, you probably won’t get a lot of money in the end. of the day anyway,” Mao noted. . But at the same time, your existing investors will need to consent to any liquidation preferences in new financing contracts, as this will alter their existing rights.

Incorporate anti-dilution rights

Anti-dilution rights are built into convertible preferred shares to help protect investors against the potential loss in value of their investment. For example, if an investor buys shares at $10 and a subsequent round sells at $5, the original investor will receive more shares to adjust to the new price. It’s not that simple, however.

“In Australia they are almost always referred to as broad-based weighted average anti-dilution duties,” Mao said. “Which means that investors don’t get the full adjustment from that lower stock price that’s involved in that down cycle, but they will benefit from a price that is somewhere between the price that they have paid and the price of the down cycle.

“As you grow and go through different rounds of funding, you need to be aware of how these anti-dilution rights interact with any other interests you have in place within the business.”

Consider Forced Exit Provisions

Another consideration when making the deal is to take into account the forced exit provisions. They are increasingly common in late-stage financings and terms can vary widely.

“It could be as simple as asking the company to consider in good faith what their options are,” Mao said. “Or it could go so far as to allow the lead investor to force the company into an exit based on advice they received from an adviser they put in place and a buyer they put in place. ‘he found.”

Once the deal is done

Be aware of new financial reporting obligations

Many startups that raise larger late-stage funding rounds will deal with Australian funds that are Seed Venture Capital Limited Partnerships, or ESVCLPs. These are a type of fund that can be very tax efficient and attractive to investors, but they are heavily regulated. Some of these regulations will impact how you run your business.

“In particular, one of the requirements is that if the total value of a company’s assets exceeds $12.5 million, it must have an auditor and prepare audited financial accounts,” Mao advised. “It can be expensive compared to what some companies are used to, but it can be a great opportunity to mature the company’s reporting practices, get its house in order and identify any problems in the financial and tax history of the company and to solve them. avoid unpleasant surprises, say when you arrive at an exit.

Consider the Structure of ESOP Offerings

Mao’s final consideration for late-stage financing deals concerned the structure of ESOP (Employee Share Option Plan) offerings.

“Most startups in Australia use what is called concessional start-up rules for its ESOP and doing its ESOP offerings to allow its employees to get tax breaks commensurate with their equity,” he said. she explains. “One of the requirements of these rules is that an option offer must have an exercise price at least equal to the market value of the company’s common stock at the time of the offer.”

You’ll either need to rely on your most recent round’s share price or get a formal valuation to determine what the market value of your common stock is.

“That means your employees will probably have to pay a lot more for their capital than they would have done before,” Mao warned. This is a natural consequence of your business growth and value, but it’s something you’ll want your valued employees to be comfortable with.

For more information on Sophie Mao and LegalVision, visit legalvision.com.au

Watch Sophie’s Idea to Unicorn session here:

idea to unicorn


This article is brought to you by Startup Daily in partnership with LegalVision.

Feature photo: Sophie Mao, LegalVision

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