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The first capital raise for many startups is known as a ‘friends and family round’. Undertaking your first capital raise can be daunting as there are several commercial and legal factors to consider. This article sets out the key considerations when approaching a friends and family round. We will also explain: 

  • how to best structure your company;
  • whether you should raise capital from investors; 
  • how to set the terms of your investment;
  • the relevant restrictions on raising capital; and 
  • how to best prepare investment documents.

Establish Your Company Structure

Before you can raise capital, you need to have your business structure set up. If not, there will be no company for your investors to invest capital towards.

If you are establishing a startup, it is best to use a company structure for your business. This is because companies have several features which are beneficial for startups, such as:

  • limited personal liability for your shareholders;
  • ability to issue shares to investors and employees; and
  • the company structure is scalable and easy to expand (for example, adding subsidiaries).

When you establish your company structure, you should also consider whether you will use one company or two companies. This is known as a ‘dual company structure’. In a dual company structure, you have a holding company which holds cash, intellectual property and other assets. Further, you have an operating company which enters into contracts in the ordinary course of business. A key benefit of a duel company structure is that the holding company’s critical business assets are protected from the operating company’s liabilities.

Should You Raise Capital From Investors?

Before you raise capital from investors, it is essential to ask yourself why you want to raise capital and whether you are in the best position to do so. You should consider:

  • Can you successfully bootstrap without external investment?
  • Can you deploy the invested capital effectively (i.e. what key milestones can you achieve with this capital)?
  • Are you ready to issue equity to others?

Additionally, you should consider whether you can negotiate terms that are acceptable and beneficial for the company. For example, can you negotiate a good enough valuation that the impact of raising capital will not be too dilutive?

Although it is tempting to raise capital whenever you need cash, it is important to remember that giving up ownership of your company to third parties is a serious matter and has significant long term impacts on your company. Hence, you must ensure you are ready for this.

Once you have decided you want to raise capital, you can prepare a pitch deck. This sets out the business plan and proposition, the investment opportunity, details about the founders and team, and the milestones you will achieve with this capital. A pitch deck will give potential investors a snapshot of why they should invest in the company.

The Terms of Investment

As you progress in negotiating your friends and family round, you should consider the terms of the investment, including:

  • how much money do you want to raise?;
  • what is the pre-money valuation of the company before the raise? This will determine how much dilution you will take as a result of the raise;
  • what types of shares will investors have? Many startups will offer ordinary shares in a friends and family round. However, more experienced investors may want shares with certain preferential rights to protect their interests;
  • will any investors have a role in managing the company? For example, is there an investor who you will want to be a director of the company?; and
  • what rights and access to the company will shareholders have? For example, consider what financial information you are willing to provide to shareholders and how frequently you will provide it.

Restrictions on the Number of Investors

To protect investors, New Zealand has certain restrictions on how companies can offer securities. Generally, before making an offer, the company must prepare a product disclosure statement and lodge certain information on the online offer register. This process can be complicated and costly. Therefore, many startups will ensure that their friends and family round falls within certain exclusions to these disclosure obligations.

The most relevant exclusions to these disclosure obligations for family financing are:

  • offers to close business associates or family members; and
  • offers made to no more than 20 investors in a 12 month period, where those offers raise less than NZ$2 million.

As such, you must ensure that you raise from less than 20 investors in 12 months (or you must otherwise ensure that investors are close business associates or family members) as part of your friends and family round. 

Further, the disclosure obligations will not apply if you raise capital from:

  • professional investors;
  • investors with large assets or turnover; or 
  • an investor who is individually investing at least NZ$750,000.

Investment Documents

To complete your capital raise, you will need the following documents:

  1. Term Sheet – while not necessary, a term sheet speeds up the negotiation process with investors and the formal investment documents are based on this;
  2. Share Subscription Agreement – this is the formal investment document under which the investor agrees to invest in exchange for being issued shares;
  3. Shareholders Agreement – this is an agreement between the company and the shareholders which sets out how its shareholders and directors will govern the company;
  4. Company Constitution – this sets out the rights attaching to the investor’s shares; and
  5. Ancillary documents – this includes company resolutions, share certificates and share register. 

After you issue shares to your investors, you must also notify the New Zealand Companies Office within ten working days.

Key Takeaways

Approaching a capital raise can be a daunting and complicated task, especially as a new business. When you are undertaking a friends and family round, there are several commercial factors you will need to consider. For example, you must consider whether you should raise capital and if so, what the commercial impact of this will be. 

Likewise, there are legal factors to consider. You should prepare appropriate investment documents and ensure you follow correct corporate processes to issue shares. Being aware of what is involved will put you in a better position when negotiating with investors and ensure you can handle the impact of new shareholders on the company.

If you have any questions on raising capital, you can contact LegalVision’s New Zealand startup lawyers on 0800 447 119 or fill out the form on this page.

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