- 4 Steps For Start Up Capital
- February 26, 2016 | Author: James H. Gulseth
- Law Firm: JGPC Business & Corporate Law - Pleasanton Office
Raising startup capital is one of the first steps to getting your startup business going.
But the process is not simple. If you aren’t careful you could lose control of your business to someone else.
In today’s post we are going to show you the basics of raising startup capital in a way that will keep you in control of the business you create.
Special Note: If you need startup advice about structuring your startup you can set up a meeting with a member of our team of startup advisors by clicking here. We are always happy to chat with you by phone or email or meet with you for up to a half hour without charge to discuss your startup.
The Biggest Mistake a Startup Founder Can Make
What’s the only thing worse than going out of business?
Over the last few decades I’ve seen thousands of businesses come and go and the only thing worse than seeing an entrepreneur fail is seeing one succeed and then seeing the founder lose control of the business the founder built.
It happens all the time, but with proper legal advice and structuring this danger can be prevented. But the business structuring to prevent a loss of control must be built into the formation documents from the beginning. How do you insure that you do not lose control of your business? Well, first of all:
Step #1: Write Your Business Plan
You should write a business plan, however short and incomplete, if only to help you answer the following basic questions. First, what is your business going to sell? Is it a product? Is it a service? And to whom are you going to sell your product/service? How much will it cost to create/provide your product/service? How much will you have to sell it for to make a profit? What volume of product/services will you have to sell to make your business viable? How many products/services will your business have to sell each month to reach a break even cash flow; that is how much total cash flow will your business need to make enough net cash flow to pay all the businesses bills and expenses and to pay yourself a living wage. This is a break even cash flow.
Step #2: How Much Money Do You Need to Raise?
Once you have answered question of “How many services/products do I have to sell each month to reach a breakeven cash flow?” Only then can you begin to figure out how much cash you will need to reach that level of business activity (volume of services/numbers of products) that will provide enough cash flow to keep the business, and yourself, going without additional outside money.
You need to estimate how much money will it take to get your business up and running and generating enough cash so that you and your business can continue to operate without additional outside capital or loans? Until your business begins to generate enough income to keep it operating, and paying you enough so that you can survive, you and/or your investors/lenders will have to feed it cash each month to keep the business operating.
This is important. Until you reach that break-even cash flow you are losing money every month and you’re going to have to continue to feed the company to keep it going. Once your business hits a break even cash flow, and that includes paying you/the founders enough to keep the founders going, then your business can survive without additional cash. Your business may not be making any profit at this point but at least it can support you, pay its bills and stay in business without additional capital or loans.
The third question you need to ask yourself is “Where is this initial investment money going to come from?
Step #3: Who Are You Going to Raise Money From?
Figuring out how much money you need to raise will help determine what type of entity you need to use, what type of capital structure you must use and how to set up a capital structure that will leave you in control of your company. Figuring out how much money you need to raise to get to a break even cash flow will also help dictate where you will need to look to find the money that you need.
If your business plan tells you that you need a lot of money to reach a break even cash flow, say two million dollars or more, then you will know you that you will probably need to go to professional investors such as venture capital companies and/or wealthy (and sophisticated) angel investors to find that much money. There are certain types of entities and types of capital structures that professional investors will be looking for, and you probably should structure your start up business to meet these expectations.
If you do not need that much money (say anything between one and two million dollars, depending upon your place in the financial hierarchy) then you probably might want to consider an initial focus on raising money from the three “F” groups (Friends, Family and Fools) to get some business traction and then seek to raise the rest of the money by various private offering exemptions.
If you need less than a million dollars, you probably could think about raising a significant part of that from the friends, family group and then think about various private offering exemptions targeting angel investors (non-professional investors).
Types of Investors
Friends and Family Investors
Friends and family usually don’t invest with you solely because they are looking for a big return. They invest with you in part usually because of their relationship with you and they want to help you and see you succeed. Their motivation is different from that of a VC or angel investor. They’re trying to help. Usually they are going to be small investors.
Angel Investors are people with money who are trying to invest in a company that they think has promise. They are hoping that you will be their Mark Zuckerberg. These are not Friends or Family, but they usually aren’t professional investors either. They are generally not as rigid and demanding as professional investors.
Angel investors are really interested in investing. They aren’t doing it for personal reasons. They’re investing because they are betting on you being their Mark Zuckerberg and they want to get rich out of the deal. They think it’s a good investment and they’re willing to risk a certain amount of money to get on the ground floor of what they think may be a big thing. It’s a high risk but potentially a high reward investment for them. And it would not be at all unusual for an Angel investor to invest $50,000 to $100,000 or more into an investment that they thought had real promise.
Angel Investors probably will be more demanding in terms of the deal points than the Friends and Family group might be. For example, Angel Investors probably won’t take non-voting common stock. You can assume that Angel Investors will either want at least common voting stock and perhaps even preferred stock. There are numerous Angel Investor groups in Northern California that you might be able to work with.
Professional Investors, Like Venture Capital Funds
The most expensive money you will ever take is from professional investors like Venture Capital Groups. The professional investors will get every ounce of flesh off of your company that they can. You need to be careful they do not take your whole company in the process. You need to be careful in negotiating with professional investors. You would never want to attempt that without experienced legal help. And you might want to be a little skeptical of any lawyers and law firms the Venture Capital groups send you to. Those referrals will be to the lawyers and firms that do business every day with their Venture Capital friends. Our experiences are that these lawyers and firms are not always looking out for the best interests of their start up clients. They are often more interested in putting together the deal for their Venture Capital friends than getting their startup clients the best deal.
Step #4: Maintain Control of Your Business
Once you know how much money you need to raise for your start up business to reach a break even cash flow, you and your lawyer can start putting together a capital structure for that business. This capital structure should allow you to raise the money you need to raise from your target investors, comply with all federal and state securities laws and yet maintain control of your start up business.
You are going to transfer all of your intellectual property to your entity (probably a corporation or LLC) in exchange for issuance to yourself of a certain amount of stock as founder’s stock. The amount and type of stock you issue to yourself is a crucial part of the capital structure of your business start up. This founders’s stock and the management structure of your start up must be chosen to maximize the probability that you can legally raise the amount of money that you need to raise without giving away control of your start up company.
And you must always remember that before you think about approaching anyone with an offer to sell securities (and every type of stock you offer to sell is a security), you really want to make sure that you are in compliance with all federal and state securities laws. You need to work with an experienced start up attorney to insure compliance with securities laws.
This article was originally published on JGPC.com.