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The myth and the mystery of the fundraising process

Image Credit: André François McKenzie (@silverhousehd)

This article is written by Shing Lo and Max Latchmore, venture capital lawyers in the market leading venture capital practice at international law firm Bird & Bird LLP. Shing and Max work with their clients to help turn ideas into reality. In particular, Shing and Max help fledgling companies take their first steps into the business world, providing insight into the world of investment fundraising.

From a founder’s perspective, the process of raising funds to fuel the brainwave can resemble a black hole of Eventbrite tickets, template introductory emails, and speculative coffees with that friend of a friend of a friend. This article will unpick some of the myth and the mystery of the fundraising process and provide you with a renewed sense of optimism around the possibilities of launching your beauty business.

Getting by with a little help from your friends

Typically, a company’s first injection of investment will be from a familiar source. Alongside personal investment from founders themselves, early stage companies are often funded with the support of family and friends. These sums are rarely substantial, but can be vital in financing that first website, that initial R&D or that first product.

Family and friends’ investments are often procured on simple terms as the individuals concerned are not simply motivated by profit; they are rooting for your personal success too. Furthermore, where such investors are seeking to rely on SEIS or EIS, the investments tend to be in the form of ordinary shares. In contrast, venture capitalists’ money comes with terms such as preference rights, minority protection rights and commitments from the founders and the company.

Stand out from the Crowd

Crowdfunding platforms have also become a very popular source of early stage fundraising particularly for consumer based businesses. Platforms such as Crowdcube and Seedrs provide companies with a forum to market to retail investors (i.e. individuals rather than corporate wealth), who are also potential future customers. The collective force of 500,000 investors in one place quickly adds up.

The downside of taking investment from a crowd-funding platform is the administrative burden that this can place on a company. For example, you may want to offer pre-emption rights to your shareholders (which is, broadly speaking, a right of first refusal over any new shares issued). This would be a simple process where you only have 5 shareholders who are all family or friends but this becomes significantly more challenging where you find yourself with 350 – 400 shareholders, each holding an infinitesimal percentage of the company. As crowdfunding platforms do recognise this issue, we suggest exploring with your preferred crowdfunding platform the possibility of using a nominee structure to help ease the burden of managing a large crowd of shareholders.

Easy as A, B, C

Once a company has launched and is showing signs of traction (or potential traction), the next stage of a company life cycle is obtaining sufficient funding in order to grow. For example, imagine your brainwave is a face serum. You are currently creating the serum by hand, and in order to grow you need to take on investment to outsource the manufacturing.

At this point, you may wish to consider engaging with a venture capital fund.  These funds often provide value beyond financial investment, which can be of great use for a young business in need of business guidance and connections. The sums invested will usually be substantially larger than those invested at family and friends stage, and as such venture capitalists will ask for larger portions of equity and more extensive protections than were provided to your family and friends.

Trading equity for funding is an inevitable part of your company’s lifecycle, but it is important you do not give away too much equity too soon. Ensuring you have experienced legal representation in discussions over your Series A, B and beyond, is vital to ensure the company’s investment documents are appropriately set up not to impede future financing rounds and growth, and the founders continue to have the ability to steer the strategic direction of the company.

Practical tip?

Ensure that your share capital structure is up to date. It is not uncommon for companies to promise shares to employees or advisors without documenting anything or seeking tax/legal advice. It will be difficult to update this once term sheet discussions have begun, and investors will be unimpressed by founders who have not managed their shareholder base appropriately and may be unnerved by the prospect of issues they are not made aware of.

Familiarise yourself with cap tables and ensure your register of members is up to date. These are the two documents which an investor will always want to see. A cap table is a visual representation of your company’s shareholding pre- and post-investment round. A register of members simply documents who holds shares in the company, what shares they hold and when they took ownership of the shares. A shareholder is not legally a member of the company until they are added to the company’s register of members, so keeping this up to date is essential in providing an accurate representation of your company to investors.

The Red Tree is the UK’s leading international beauty brand consultancy and a powerhouse of ideas, insight and inspiration. For an informal discussion on how we might help you, please contact us.

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