So you’ve started a business, and it’s starting to gain some traction. Customers are raving, client lists are building and your product is, well, actually working pretty well! These are all good things, and things that you should be very proud of. However, from here, the next step can be a crucial decision for the future of your business.
Often, it comes down to one very basic question: Where would I like the business to go from here?
If your answer is ‘onwards and upwards’, well, this means you’re aiming for growth. And to get ‘growth’, the reality is, you will often need more money. How else would you hire that new super smart (albeit a little kooky) developer to stop those never-ending bugs infiltrating your site!?
In this article we consider the ways in which your company can raise funds to allow growth, and how you can decide which option will suit you, and your business, best.
You need money, but where will it come from?
In general, start-ups can consider two broad options:
1. You dig deep into your pockets, you crack that money box, and even sell that fancy car of yours to pull together the required funds yourself, otherwise referred to as ‘Bootstrapping’; OR
2. You offer others (whether they are family, friends, wealthy folk or even venture capital funds) a share of your business in return for money (or capital) injected into your business (otherwise referred to as a ‘Capital Raise’).
At Cake, we’ve seen our fair share of start-ups at this fork in the road, and our focus is to make sure they always manage their equity in the most effective way possible.
Bootstrapping – What, why and when?
Bootstrapping means launching or growing a venture using the founder’s own funds, and sustaining it by its own revenues. This means you will be dipping into your savings accounts, selling those golf clubs (that you never use), or even working two jobs to keep the venture going.
While we may make it sound kind of, well, horrible, it’s not all doom and gloom. A key difference between bootstrapping and a capital raise is that you retain all the equity in your company. In other words, you are not giving away any ownership, or shares – it’s all you!
This means that if you do manage to get through those early bootstrapped founder times, and your business booms, you can forget about shareholder meetings, paying dividends to investors and worrying about who is doing what with their shares – the business is your game, and you call the shots.
Why would I bootstrap instead of doing a Capital Raise?
There are a few situations that may indicate bootstrapping will work for you, for example:
- you have enough savings to put money into the business yourself, and you’re not overly concerned of the risk of losing it if things don’t work out as planned
- the cash-flow of the business is strong, and you’re able to invest profits straight back into the company (ahhh, a profit making start-up, the dream)
- or maybe you actually don’t need much money to keep the business growing at all – for example, many online businesses have low overheads and are able to grow steadily without large cash injections
However, to be clear, just because you might choose to bootstrap initially doesn’t mean you’re a bootstrapper for life. Often, it is quite the opposite. If a start-up can bootstrap for a while, this will mean that once they are ready for raising the big bucks, they have more shares to give!
Just look at Australia’s arguably most successful start-up, Atlassian, who bootstrapped for 8 years before jumping into the raising game and injecting over $200 million in just four years!
Or another favourite example of ours, Bean Ninjas, where founder Meryl Johnston launched the business in only 7 days with just $1,000, wasting no time looking for paying customers, to get the (now highly successful) ball rolling. Following that, Bean Ninja’s also took the capital raising route, and have been growing steadily ever since.
Capital Raise – What, why and when?
So, you’re considering a ‘raise’ – that holy word that bounces off the brightly painted walls in any co-working space, making the culprits feel just that little bit more sophisticated than the rest – “Sorry guys, I’m in a pretty hectic raise right now, might be getting flown to L.A. to meet with the big shots, best of luck with your little project!”
While I poke fun at the concept, a raise can actually be one of the most vital ingredients to the growth and success of any start-up. The key is knowing how to go about it, and what it may involve – don’t just sing loud about it, make it happen, and make it work.
If all of this is quite new to you, it can be good to get on top of your business finances prior to delving into your first raise – the Bean Ninjas financial literacy training can help you prepare your accounts in Xero and validate whether or not your business is on the right track financially.
In general, a capital raise refers to an injection of money into a business in return for shares.
But who will inject that money? Where do you find these saviours of our start-up land?
Well, it depends… For example:
Family and friends
If you’re just getting started, there is often no point going straight to the silk-suited hotshots on level 54, asking for the big bucks. Here, the stage you’re at is usually considered as a ‘Pre-Seed Round’.
Start with your family, friends, and close contacts. Here, often the family and friends are investing in you, rather than your business – they want to come along on your journey, and want to see you succeed. But beware – just because they are close doesn’t mean you don’t need share terms, share certificates, and official documentation – do your share issues properly, and avoid sticky situations down the road.
If you’re already on the way, and you’re looking for some bigger bucks than Uncle Joe may be willing to dish out, consider finding an ‘Angel’. An Angel is a high-net-worth individual who generally has a special expertise in a given field (for example, app development), and who invests in early stage companies. Angels are frequently involved in early fundraising rounds called ‘Seed Rounds’. They get in early, and are rewarded in decent equity for the higher risk they take. The plus with these folk is that not only will they come into your business with money, but they come with skills, expertise, and contacts – they are now part of your business, and they will help to make it work.
If you’re really looking to go large, maybe you can consider approaching a venture capital fund. Generally VC funds are looking for the next big thing – they are planting a lot of money, and want it to grow, a lot. But to be clear, these VCs are busy and in high demand – a cold email with a 2 page business proposal simply won’t cut it. VCs want to see proven revenue, growth, and return. If you’re not at that stage, they generally won’t give you the time of day.
If you are looking to go for the VC route, you will want your pitch documents and presentations in perfect condition to even get close to sealing that deal. The VC will want to do a major due diligence review of your business before committing any capital, so make sure it is all squeaky clean.
So this one is a little bit different to the others, so stay with us. In short, a Convertible Note is a way to fundraise through a mixture of debt (a loan) and equity (giving away shares).
It involves an agreement between the company and the investor to loan money to the company, in return for shares on the happening of some certain event, for example, the company completing a successful capital raise of $X in the future. And if that event doesn’t happen, the loan is paid back by the company – simple as that.
The huge advantage with this form of raising is that you don’t really need to know what your company is worth to get the funds in your account – you simply agree that when your company does eventually do a raise, and your equity is valued, the lender will be provided shares at that value (with any discount that might be agreed).
So no need to inflate figures and beg investors for some ridiculous amount based on what you think your company will be worth – get a Convertible Note, get the money in the account, get the business moving and prove your worth later on! Convertible Notes are often used to keep a company moving between financing rounds and can be crucial for keeping the momentum going. We say this from experience – Cake has used Convertible Notes in its early stages, and can vouch that where your company simply does not have time to slow down day-to-day activities to finalise an equity raise, a Convertible Note can be the perfect solution to keep you charging ahead.
There are heaps more ways to raise money for your company. For example, Crowd-Sourced Funding (where you can offer shares to hundreds of smaller shareholders online), Accelerator Funding (where you can get both funding and business support in one neat package), and even Employee Share Schemes (where employees are offered the opportunity to purchase shares in return for their services).
Cake loves all of these options, and has a particularly effective offering to allow companies to run their own employee share schemes with minimal time required.
While Employee Share Schemes are not often considered as a primary investment strategy, they can actually be seen as a good way to have employees invest their time and effort into your company instead – invest sweat rather than money! Stay tuned for an article on this soon.
I’ve picked the raise strategy for me – now what?
When you’re thinking about a raise, whether with family or a venture capital fund, it is really important to make sure you have structured your equity properly, and that all of your documentation is sorted.
In our experience, the company that is most prepared for a capital raise ends up with the best deal. The last thing that the investor wants to be doing is having to drag the start-up along, and subsequently losing faith from the get go – cue passive aggressive late night emails and regretful founders.
Here are a few key things to consider:
How many shares does your company currently have on issue? Have you structured it to allow you to retain the right percentage of ownership after any investment made? Have all share issues and share transfers been updated in your share registry and to the regulators?
To be clear, you can’t go out and ask for money in return from shares from anyone and everyone – there is a strict legal process to follow. In general, in Australia a company is unable to raise funds from any investor without first issuing a detailed disclosure document (often referred to as a prospectus).
However, start-ups are able to raise funds from specific investors by applying exemptions to the disclosure requirements under the Corporations Act. For example, the most common exemption we see used is the 20/12/2 rule – where a company can raise up to $AUD2 million, from a maximum of twenty investors, over any 12 month period (as long as the offers are personal offers). To be safe, we always recommend checking what exemptions you will be applying.
Whether you’re offering 3% ownership to Uncle Joe, or 49% ownership to the silky-suited VCs, you want to know how this will affect the way you run your business. What rights will the investors have? Will they get a seat on your board? Can they sell their shares? These are all issues which can be set out in a Terms Sheet. While not all companies will use a Terms Sheet for straight forward investments, any big investment will often involve some negotiation.
Understand short-term and long-term financial needs of the company. – Showing investors that you’ve got a clear grasp of the company’s financials is an important step in raising capital. Make sure you’ve set up your accounting software correctly (we recommend and use Xero), and have a full set of financials per year since the first day of trading that include the Profit & Loss (P/L), Balance Sheet and Cash Flow.
“It’s one thing to have a great idea and another to have a sustainable business model. Investors are looking for founders who understand their financials and key metrics.” Meryl Johnston, chartered accountant and CEO of Bean Ninjas.
- Provide accurate forecasts of revenue, market share, and margins. – A forecast that sounds ridiculously ambitious might cause investors to question the accuracy of the rest of your pitch, but a forecast with small expected growth isn’t going to excite investors. Presenting forecasts that sound reasonable helps to build trust. A forecast needs to take into account assumptions about the future, not just historical data. Meryl recommends exporting the historical data out of Xero and then using excel or a financial modeling tool like Fathom or Spotlight to build the forecast (probably Excel for non-accountants).
“You should be able to articulate your thought process behind the assumptions in your financial model and respond thoughtfully when investors push back on those assumptions.” – Meryl Johnston
Other important stuff
The way a company is run is governed by their Constitution and Shareholders Agreement (if they have one). These company documents will set out how the company can issue new shares, what rights shareholders have, and how the general business will be managed. These documents should always be reviewed prior to getting started on any raise, and should be amended if necessary to save you headaches down the track. Larger investors will also want to see these documents, and may request changes before they invest – for example, a VC will often want all the terms from their Terms Sheet built into a Shareholders Agreement.
Time to hustle
The perfect path to growth is not the same for any two businesses. You need to consider your personal goals, your business goals, your risk appetite, your financial situation and much more.
Cake makes this easy – Cake can set up your share registry in a user friendly cloud-based platform (see-ya later spreadsheets), manage share splits and issues, and definitely will help facilitate the sending and execution of offers and investments – simply click a few buttons, get the money in the account, and shoot that spiffy new share certificate off to your newest shareholder – it is literally that easy.
If you liked this article, check out 7 Capital Raising Mistakes a Start-up Should Avoid or The Capital Raise Checklist – Are you ready for a raise?
This blog is designed and intended to provide general information in summary form on general topics. The material may not apply to all jurisdictions. The contents do not constitute legal, financial or tax advice. The contents is not intended to be a substitute for such advice and should not be relied upon as such. If you would like to chat with a lawyer, please get in touch and we can introduce you to one of our very friendly legal partners.