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What is the Best Business Structure to Raise Capital for My Startup?

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It is essential to consider how your business structure will affect investment opportunities before raising capital. Your business structure will impact whether you can raise capital and what amount you can raise. It is possible to change the structure of your startup ahead of any capital raise if required. This article will outline various business structures and which is most suitable depending on your capital raising strategy. 

Sole Trader

If you are a sole trader, your startup is likely small and in the early stages of growth. A sole trader structure is inexpensive and straightforward to set up and operate. However, you will have unlimited liability, meaning you can be personally liable for any damages or unpaid business debts. 

A sole proprietorship is unlikely a suitable business structure if you want to attract venture capitalists or large investments. This is because a small business carries a high risk for investors. Likewise, it will be challenging to convince them to invest in you. In addition, investors cannot purchase shares.

However, a sole trader business structure works well during a seed funding stage. It is common to raise money from friends and family, banks, angel investors, and crowdfunding platforms during a seed funding stage. Such sources of finance are likely to invest in a sole trader business, although banks may charge a high-interest rate. 

Trusts

Operating a business through a trust provides a number of advantages. For example, trusts offer a variety of asset protection and tax efficiency. However, this business structure may present challenges when raising capital. This is primarily because trusts are complex structures involving multiple trustees and beneficiaries. The complex nature of trusts often deters prospective investors, who may hesitate in the face of an ambiguous business structure and the inability to have direct control over their ownership. Further, trusts do not provide for the purchase of shares like other business structures do. As such, raising capital through such an investment can be challenging.

Instead, investors are more likely to prefer a business with a more ‘traditional’ business structure, such as a company. In a company, you can clearly define ownership and investors can purchase and sell shares. As a result, businesses operating through a trust will likely find it difficult to attract external investment, especially from venture capitalists and angel investors.

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Private Company

You will not be personally liable for any debts or damages in a limited liability company.  A company is a simple vehicle through which you can have as many (or as few) directors and shareholders as you like. Your shareholders will share in the business profits in proportion to their ownership percentage. With a limited liability company, you have a better chance to prove your traction, steady cash flow, and substantial customer base to investors. Bigger and established startups pose a lower risk than smaller startups and attract more investors. 

Raising capital in a company is straightforward. Investors contribute cash to the business for growth and, in return, are issued shares (obtaining a percentage ownership in the company).

Investors will generally be looking for a return on their investment, meaning a future liquidity event must be on the cards. The two main ways for a liquidity event to occur are via:

  • a trade sale (sale of the business assets or shares in the company); or 
  • an initial public offering when you list the company on the stock exchange.

Dual Company Structures

A dual company structure refers to the creation of two separate entities: the parent company and the subsidiary company. Businesses often use this dual company setup to separate their operational activities from their assets. 

Fortunately, dual company structures have several advantages when it comes to raising capital. First, a dual company structure allows for flexibility by enabling each entity to individually attract investors. For example, consider the parent company, which focuses on obtaining investment to expand business operations. In that case, the subsidiary company might separately focus on obtaining funding for research and development. 

Another advantage of the dual company structure is that it minimises the risks of raising capital. Potential investors will see a much lower risk when assets and liabilities are delegated between more than one company. This can lead to more confidence in an investment and an increased chance of obtaining funding.

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Key Takeaways

Considering how your business structure will affect investment opportunities before raising capital is critical. Your business structure will impact whether you can raise capital and the amount of capital that can be raised. Some business structures to consider for raising funds for your New Zealand startup include:

  • sole tradership;
  • trusts;
  • private companies; and
  • dual company structures.

If you need help understanding what business structure is best to raise capital, our experienced business lawyers can assist as part of our LegalVision membership. You will have unlimited access to lawyers who can answer your questions and draft and review your documents for a low monthly fee. Call us today on 0800 005 570 or visit our membership page.

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Emily Young

Emily Young

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