Funding: Getting Your Financial House in Order.
FINANCIAL MATTERS: UNDERSTANDING OPTIONS AND CONSEQUENCES.
A common reason businesses fail is financial. Whether it be an insufficient estimate of the true cost of starting what you have in mind, an unrealistic expectation about resources you might tap into, or a misconception about how quickly you will start making money, they are all financial pitfalls that can trip up the best laid plans. So once again, it’s time to analyze situations to better predict outcomes.
>> ANGEL, SEED OR VENTURE CAPITAL?
Interested angel investors? How exciting. But before you sign an early-stage, seed or angel term sheet, make sure that you understand, from a legal perspective, all the consequences and conditions.
– Investors term sheet or letter of intent
A term sheet, or letter of intent is simply the proposed terms and conditions of the financial arrangement in in writing. In the case of angel investments, the term sheet can be prepared by the start-up or the angels. Most of the terms are non-binding, with the exception of certain confidentiality provisions and, if applicable, exclusivity rights.
– Angel vs. venture capital term sheets
At times, you may find little difference between an angel or seed investor term sheet and a venture capital term sheet. Both the investment structures and founder covenants required by angels are less constrained by standardized institutional practice.
– Key provisions in an angel term sheet:
Angel investment structures vary, but angels generally invest in one of three types of securities:
- Common shares
- Convertible preferred shares
- Convertible debt
Angel investors often invest through convertible debt. This involves the investors loaning money to the company, with the loan amount being convertible into equity shares of the startup.
Key Economic Terms
Essentially, the key economic terms consist of:
- quantifying the preferred return of the investment
- quantifying any accruing earnings on the investment
Board Structure and Reporting
Often angels require some formal representation on a startup’s Board of Directors, typically as a (non-controlling) board member or observer role. It’s also not uncommon to require some reporting policies and frequent updates.
Corporate Governance and Shareholder Agreements
Angel investing almost always require a shareholder’s agreement among the founder group and the new investors.
The term sheet should define the timeline and process from the date of signing the term sheet to the closing date, as well as the conditions for closing, including due diligence.
Most angel term sheets include some basic confidentiality obligations especially if the proposed investors have not signed a non-disclosure agreement.
>> CROWD FUNDING
Crowd Funding is a funding method where individuals (not investors in the traditional sense of the word) fund a business project with their own money. It is being used in support of a wide variety of activities from artists and journalists, political campaigns, charitable purposes, invention development, entrepreneurship, to scientific research and more.
It’s administered through a networked and publicly observable platform. Because it is relatively new, the state and federal rules governing these kinds of solicitations and securities are still evolving, so it is strongly recommended to seek professional advice before engaging in crowd funding.
The U. S. government does have grant programs and generally speaking, virtually all grant money flows to local governments, state agencies, and nonprofits. If you still want to look for grants, you can search at www.grants.gov. The following is an excerpt from www.sba.gov:
“SBA does not provide grants for starting and expanding a business. SBA has authority to make grants to non-profit and educational organizations in many of its counseling and training programs, but does not have authority to make grants to small businesses. Some business grants are available through state and local programs, nonprofit organizations and other groups…. Grant funding is generally restricted to very specific audiences. These grants are not necessarily free money, and usually require the recipient to match funds or combine the grant with other forms of financing such as a loan. The amount of the grant money available varies with each business and each grantor.”
Traditional and non-traditional lenders have criteria on which they qualify or reject business loan requests. The following three are primary considerations:
- CHARACTER: What is your credit history and score? Lenders are looking for reliable borrowers who have demonstrated responsibility and have a high credit score (700 and above) over a period of at least 3-5 years.
- CASH: Lenders expect you to have “skin in the game” and be able to put up 20-30% of the total startup cost either as cash or cash plus equity investment.
- COLLATERAL: Lenders generally expect you to pledge assets against the loan that have a net value greater than the loan amount. Keep in mind that purchase value isn’t resale value and banks discount the value of even brand new equipment to what they think they could get if they have to sell it to satisfy the debt.
- SBA Loans: The SBA does not directly make loans but does have a variety of loan guarantee and/or support programs available through commercial lenders and Certified Development Financial Institutions (CDFI’s). For more information visit www.sba.gov.