What needs to be done to do an early stage capital raise? How should you prepare for a raise?
In our opinion, the best thing you can do in these tough economic conditions is to extend your runway. If you’re an early-stage company looking to go all the way, you may need some support to get you through. The most logical way to do this is to do a capital raise.
However, if you haven’t done a raise before, there are a few things you should think about before you dive on in. By taking a few simple steps before you ask an investor to ‘sign the dotted line’, you can save massive headaches later.
Clean up your registry
Share Split:
Often, a basic first step required will be to do a Share Split.
This is needed where a company may only have a small number of shares on issue. Before issuing further shares to a number of new investors, the Company can split the existing shares into a larger number.
For example, a Company could turn 100 shares on issue, into 1 million. As a result, each share will obviously be worth less, but there are more shares to play with. Share Splits are also useful where the initial share price is particularly high, to make sure the investors can consider affordable options.
A Share Split is an easy step, but one that is always good to get done early on. It is also good to show the potential investor that you’re prepared
Employee Share Schemes
If your Company has an ESS or an ESOP, you want to make sure that it is up to date and accounted for in your share registry. The potential investors will want to see the ‘fully diluted’ registry, meaning the share registry that takes into account options and Convertibles Notes etc.
The Cake platform will show all live figures for undiluted and diluted ownerships, and allows you to play around with different raise goals to see what figures work best.
If you haven’t got an ESOP, but you want one, it is a good idea to get it approved before the raise. It can be as simple as getting the ability to create an ESOP factored into your shareholders agreement. You don’t necessarily have to get it completely drafted or executed yet. This way, the ESOP Pool can be factored into your up to date share registry.
Final touches
Finally, make sure your registry is current and clean.
Have all share transfers been processed? Are the shareholder details correct? Do you have contact details for all the shareholders?
Consider your Company goals
Before going to talk to investors, it is worth defining your own goals first.
You should be considering things such as:
- How much money do you want to raise?
- How much equity are you prepared to give away?
- How many shareholders do you ultimately want on your registry? Don’t forget the 50 shareholder limit for private companies.
- What kind of shareholders do you want? Active helpers, or passive cash injectors?
- And is your valuation fair? It is always good to receive feedback from someone in the industry on your proposed valuation. And don’t forget, if you’re not able to work out your valuation right now, maybe a Convertible Note is better suited for you.
What about a Terms Sheet?
Do you need a Terms Sheet for a capital raise? It depends.
Some investors will want to see a Terms Sheet which summarises the terms of the investment. Others won’t mind and are happy to just review the Shareholders Agreement instead. It will depend on the raise round, and how sophisticated the investors are.
Generally, a Terms Sheet itself is not actually binding, but just sets out the general provisions which will be included in the Shareholders Agreement. It is basically just a good way for the Company and Investor to discuss whether any changes to the Shareholders Agreement (or Subscription Agreement) are required before an investor will invest.
For example, an Investor may want a right to appoint a director under the Shareholders Agreement, and so they would include this in the Terms Sheet.
The other obvious things which could be included in the terms sheet are the share price, and the type of share being issued.
Even though the term sheet is optional, it can give your investors a quick overview of the opportunity to invest. This is important where your investors might be time-poor, so they can quickly see all the key terms.
Once a Terms Sheet is ‘agreed’ with an Investor, it should be ensured that all agreed terms are reflected in the current Shareholders Agreement.
Once the Shareholders Agreement is finalised and signed by current shareholders, that will become the binding agreement.
Where do Shareholders Agreements fit in?
In short, a Shareholders Agreement is the binding document that governs the ongoing relationship between the Shareholders and the Company. It sits alongside the Constitution of the Company and will usually prevail over the Constitution where there is any inconsistency.
Remember, the Shareholders Agreement is very different to the Subscription Agreement, which is a document specifically in relation to a certain share issue (rather than an ongoing document for the management of the Company). Cake provides an automated Subscription Agreement through its Raise platform, as part of the automated process.
If your company does not have a Shareholders Agreement, it is a good idea to get one before issuing more shares. This is because the Shareholders Agreement sets the rules for things such as which decisions will require shareholder approval, how directors can be appointed and removed, and how a shareholder can (or cannot) sell their shares.
Often, the investor will request that the Company does have a Shareholders Agreement, and they will want to see it before they commit.
However, if you don’t have a shareholders agreement, and you (and the investors) don’t want one, it is not mandatory.
Get the needed approvals
and waivers
Most Shareholder Agreements (and many Constitutions) will contain ‘Pre-emptive Rights’ provisions. These provisions basically require that before the Company issues new shares to new investors, it has to first offer those shares (on those same terms) to the existing shareholders.
You should check whether your company has these terms, and either:
- Request the shareholders sign a ‘Members Waiver’ for the raise, meaning they agree not to enforce those rights and they approve the raise to proceed; or
- Follow the process set out under the Pre-Emptive Rights, by offering the shareholders the shares on the same conditions as proposed for the raise. Don’t forget that current shareholders will often be the best investors anyway.
In practice, we find that shareholders are generally very happy to provide a waiver, as they are glad the company is growing.
Finally, get the deal done
And after all this, it is time to process the raise.
You can use the automated Cake platform to send your offers to investors and have it all signed and processed online. This will also allow for the investors to enter in their own addresses, investment entities, and contact details etc. In short, it will save a lot of time, money, and risk of data entry errors.
We know it may seem a lot, but if you follow the process, it flows smoother and faster than you might think.
Investors like things to be simple, transparent and logical. Funnily enough, so does Cake.
Get in touch to hear how we can help you get prepared.
This blog was contributed by our partners at Cake Equity
Whether you want to raise capital faster, manage your investors or give your team ownership – better your business by using Cake.
