Capital Raising

You can raise money for your new company in two main ways:

• Borrowing, or “Debt Financing”: This includes loans from banks or individuals.
• Equity financing: This involves selling ownership interests in your company to investors who become part owners.

Advantages of Debt Financing include:

• No ownership dilution: Lenders don’t become part owners and generally aren’t able to influence company decisions.
• Profit retention: Lenders don’t share in your profits—once the loan is repaid with interest, your obligation ends.
• Tax treatment: Loans are not considered taxable income to your company.
• Predictability: Loan terms are typically fixed and clearly defined.

Disadvantages of Debt Financing include:

• Limited access: Startups without a financial track record may struggle to qualify for loans.
• Collateral requirements: Lenders may require personal guarantees or company assets as security.
• Interest payments: You’ll repay more than you borrow due to interest.
• Repayment priority: You must be current on loan payments, and sometimes loans are required to be repaid in full, before profits can be distributed to owners.
• Investor concerns: High debt levels can make your company less attractive to potential investors.

Equity financing—often called a “private placement”—involves selling ownership interests in your company to investors. These investors become part owners and share in the company’s future success.

Depending on your business structure, you may sell:

• Shares of stock (corporation)
• Membership interests (LLC)
• Partnership interests (partnership)

These ownership interests are collectively referred to as “securities.”

Key elements of equity financing include:

• Valuation: You and the investors agree on the company’s value before the investment—this is called the “pre-money valuation.”
• Investment amount: Based on the valuation, investors contribute capital in exchange for a percentage of ownership.
• Preferred equity: Investors often receive preferred shares or interests, which may come with special rights and privileges.
• Negotiated terms: Investors may negotiate board seats, approval rights for major decisions, and terms for how and when they can recover their investment.

Private placements offer several advantages for raising capital through equity financing:

• Shared risk: Investors become part owners, aligning their success with the company’s performance.
• No repayment obligation: Unlike loans, you generally don’t have to repay equity investments.
• Profit flexibility: You can reinvest profits into the business instead of distributing them immediately to investors.
• Customizable terms: You have flexibility in deciding how much equity to issue, at what price, and with what rights—subject to securities laws.

This approach can support long-term growth without the pressure of fixed loan repayments.

While private placements offer flexibility, they also come with several challenges:

• Finding investors: It can be difficult to attract investors willing to take on the risk of a startup or early-stage company.
• Shared control: Investors become owners and may seek influence over company decisions.
• Regulatory complexity: You must comply with securities laws, including full and accurate disclosure of material facts—no misleading statements or omissions.
• SEC registration or exemption: All sales of securities must either be registered with the SEC or qualify for an exemption. SEC registration is costly and time-consuming, and exemptions require strict compliance.
• Consequences of noncompliance: Failing to follow securities laws can lead to:
  • Enforcement actions or legal penalties.
  • Investor rescission rights (requiring you to return their investment).
  • Allegations of securities fraud.
  • Difficulty securing future funding or completing a sale due to disclosure and legal opinion requirements.
  • SEC-imposed restrictions on involvement in future private placements.

A convertible note is a type of loan that may convert into equity in the future. It’s considered a security, so it must comply with the same securities laws as equity offerings. Convertible notes are often used in early-stage fundraising when valuation of the company is difficult to determine upfront.

Key features of convertible notes:

• The investor loans money to the company, which may later convert into shares or membership interests.
• Conversion terms—such as timing, percentage, and valuation—are defined in the note.
• Typically, the note converts during the company’s next equity financing round.
• Until conversion, the loan is recorded as debt on the company’s books.

• Faster and less expensive to draft than equity financing documents.
• Flexible fundraising—there’s no minimum or maximum amount of convertible notes that can be sold.

Investors don’t receive board or voting rights unless and until the note converts to equity.

A SAFE, or “Simple Agreement for Future Equity,” is a streamlined investment tool created by Y Combinator in 2013. It allows startups to raise funds without issuing debt or immediately determining a valuation. SAFEs are often used in early-stage fundraising when speed, simplicity, and low legal costs are priorities.

Key features of a SAFE:

• The investor provides money now in exchange for the right to receive equity later—typically during a future funding round or liquidity event (like a sale or merger).
• SAFEs are not loans and do not accrue interest or require repayment.
• If no qualifying event occurs, the investor may not receive equity or a refund.

• Faster and less expensive to draft than traditional equity or debt documents.
• Flexible fundraising—there’s no cap on the amount raised.
• Investors don’t receive board seats or voting rights unless and until the SAFE converts.

Yes, crowdfunding is a way to raise capital from a large number of investors—often in small amounts—without needing to rely on wealthy individuals or traditional funding sources. Crowdfunding can be a viable option for startups, but it still requires regulatory compliance and careful planning.

Key features of crowdfunding:

• Current SEC rules allow companies to raise up to $5 million through SEC-approved funding portals.
• Companies must file offering documents, annual reports, and financial statements with the SEC.
• Investors can pool funds through a single “special purpose vehicle,” simplifying ownership.
• Offerings must still go through SEC-approved portals, which typically charge a fee based on the amount raised.

In most cases, you cannot promote a private securities offering through general advertising or public outreach. This includes:

• Ads in newspapers, on social media, or on TV or radio.
• Website content or blog posts.
• Articles or mass emails.
• Any communication with large, undefined groups.

Typically, you may only offer and sell securities to individuals or entities with whom you have a pre-existing relationship.

Exceptions to this rule include:

• Crowdfunding: If your offering qualifies under federal Crowdfunding rules, you may advertise publicly.
• Accredited Investors: You may also advertise publicly if all purchasers are verified as accredited investors (generally high-net-worth individuals or institutions).

Generally, you can’t pay someone to help you find investors unless they’re properly licensed as a broker-dealer or agent under federal and state securities laws.

There are limited exceptions:

• Officers, directors, and employees of your company may help sell securities without being licensed—if they are not paid based on how much they raise and are not affiliated with a broker-dealer.

Risks of using an unlicensed person include:

• Losing your exemption from registration.
• Investors demanding their money back (rescission rights).
• Allegations of fraud if the arrangement isn’t disclosed.
• Enforcement actions by the SEC or state regulators.
• Harm to future fundraising or sale of the business.

What about “finders”?

• A “finder” may be allowed in very limited cases.
• A finder should only introduce you to potential investors (e.g., share contact info).
• A finder must not negotiate terms, promote the company or the security, or advise investors, and may not be paid based on how much money is raised.
• Paying commission-based fees is a major red flag for regulators.

For most private offerings:

• You must file a “Form D” with the SEC. This includes basic details about your company, its leadership, and the offering amount.
• Many states also require a copy of the Form D and may charge a filing fee.
• All filings can be completed online.
• No fee is required for the Form D with the SEC, but most states charge a filing fee of a few hundred dollars.

For Crowdfunding offerings:

• You must file with the SEC at the start and end of the offering.
• You must also file annual reports after the offering is completed.
• The SEC does not charge a fee for these Crowdfunding filings.