Startups are usually identified as companies that have business projects that involve repeatable and scalable business models. Startups are unlike any company: in the words of YIncubator founder Paul Graham: “A startup is a company designed to grow fast”.
Because they are designed to grow fast, startup valuations increase rapidly and the funding model of repeatedly raising capital is suitable.
The tools for early-stage financing of startups can make the access to game-changing financing quick and painless.
Here’s some key considerations to help get you there.
Who to bring along on your startup journey?
Your choices of investors are extremely important and should not be made lightly. Your investors not only need to believe in you and your company’s ability to deliver the value they expect but you must also ensure your investors fit with your startup’s culture and ethos. Rapport between founder and investor personalities is also key. It’s likely going to be a long journey of growth (and bumps) so make sure your investors will contribute more than cash: knowledge, experience, networks, mentoring/coaching, all delivered in a manner that fits with your beliefs and goals.
Pre-seed or seed-round financing: what’s the difference?
Pre-seed: many entrepreneurs might refer to this as a “friends and family” round, this is the first bit of money you scrape together. You’re essentially asking someone to take a massive bet and hand over part of their savings to fund your idea. Still, you’re in a position to convince someone that you’re building something that has potential.
Seed round: Once you’ve identified a clear product-market fit and possibly have made some revenue with your product, and have a team of employees. This next stage is for scaling the business.
Shares in the pre-seed and seed round financing should be distributed to your new, equity and early-stage investors because they have taken on a risk to finance the company early, and should also be entitled to a discount.
| Pre-seed | Seed | |
| Funding amount | Typically less than US$ 1 million | Typically between $500k – $2 million |
| What you’ve shown | You’ve created a bare bones product that is viable
You’ve identified a target market and a path to that market with your product |
You’ve demonstrated proof of concept and have had some traction
You’ve assembled a team to build out your business |
| Typical valuation | Typically $1 million – $3 million | Typically $5 million – $15 million |
| Target runway | 3 – 9 months | 12 – 18 months |
| Typical investors | Friends and family, accelerators | Angels and seed |
| Typical discounts for investors | For investments made with tools for early-stage financing, typically with more sophisticated early investors like accelerators, they will not immediately receive shares for their investment in the company and will have a discount on the seed round. 20% is a typical discount those days. | |
| Documents needed | If shares are issued:
Set of documents for issuing new shares (in Hong Kong: members and board resolutions; letter of application for shares; evidence of credit of the subscription price in the bank account; form NSC1) Recommended a minima, even if no shareholders agreement is made: form of agreement regarding transfers of shares and entry in shareholders agreement when professional investors come on board If no shares are issued: SAFE (Simple Agreement for Future Equity) or ACE (Accelerator Contract for Equity – an SOSV instrument) or CNA (Convertible Note Agreement) or similar contract & detailed capitalisation table to analyse possible scenarios |
Term sheet
Data room for due diligences Investment agreement (sometimes called share subscription agreement) Set of documents for issuing new shares (in Hong Kong: members and board resolutions; letter of application for shares; evidence of credit of the subscription price in the bank account; form NSC1) Shareholders agreement Optional but frequent: New articles of association be adopted to reflect liquidity preference, if any, key corporate governance and restrictions to transfer of shares provisions of the shareholders agreement |
Resources
These days, there are plenty of cost-efficient online resources that are available to startups. We recommend you check out:
General
- YIncubator Startup School
- Foundry Group Entrepreneurial Resources
- Techstars
- Kauffman Fellows & Techstars Venture Deals Course
Local
External counsel
Engaging external legal counsel even at the early-financing stage can be very valuable as it helps startups mitigate risks and reduce the potential of costly mistakes in the future. External advisors can help with analysing your capitalization table and ensuring that founders understand their options. A review of the financing round legal documentation will also help ensure a standard is met and if a sound agreement is being entered into with investors.
By the time startups enter into the equity financing stages, they will require a legal advisor to help with due diligence and systematic regularization (often needed), draft or review legal documentation for the round, i.e.,, term sheet, investment agreement, share subscription agreement, shareholders agreement, new articles of association, and prepare various corporate authorisations. All of these are needed for investments rounds and startups by this point need both legal advisor and com robust company secretarial support to ensure the legal documentation is done properly and shares are issued accordingly.
