What is Startup Equity Capital in NZ?

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Table of Contents

• What is a Startup?
• What is Startup Equity Capital?
• Who Provides Startup Equity Capital?
• Startup Equity: The Shareholder Agreement
• Key Takeaways
• Frequently Asked Questions

One of the main obstacles that many startup owners face is finding the money to turn their idea into a business. Usually, there are two ways that a business is able to raise money. This is through either taking on debt or raising capital. In practice, startups find it difficult to raise either form of finance from traditional sources like banks or institutional equity investors without raising money from friends and family. Startup founders often look to external investors once they have exhausted their personal network. This often involves pitching to early-stage equity investors. This injection of capital allows an entrepreneur to grow and market their idea. In return, the investor may receive dividend payments or sell their stake for a higher price in the future. This article will provide an overview of certain commercial considerations related to startup equity financing, including the role of shareholder agreements. 

What is a Startup?

A startup is any business that is in the early stage of its growth cycle. Most businesses will follow a cycle that sees them have exponential growth if successful. However, their startups often have a high rate of failure so entrepreneurs need to ensure their idea is valid and scalable. 

What is Startup Equity Capital?

Startup equity capital is a sum of money that is injected into the business in exchange for shares in the business. Founders need to convince investors to inject capital into their business (often pre-revenue), often through investment pitches. 

Who Provides Startup Equity Capital?

Anybody can provide startup capital but angel investors and venture capital funds are the most common. You may encounter angel investors in a variety of settings. They are diverse and consider a founder’s potential and who their key team members are. They are usually individuals who use their own money to invest. Venture capitalists are investors who primarily invest in startups that are seen to have high growth potential. They often have capital standing by, ready to be invested. Therefore, while they are keen to put their capital to work, they need to keep the interests of their co-investors in mind. 

Startup Equity: The Shareholder Agreement

Most startup equity investors require the owners of the startup company to enter into a shareholder agreement. This contract creates additional obligations between the company’s founders and the equity investors. 

Absent any shareholder agreement, NZ company law governs the relationship between you and your investors. You will find in practice that most investors do not feel that company law is by itself adequate to protect their interests. 

Below are some common terms you will likely encounter in a shareholder agreement.

Company Dissolution Process

A shareholder agreement should outline the process undertaken if the business were to wound up. This is to ensure there is no disagreement between the shareholders about how the business is dissolved. 

Exit Strategy

The shareholder agreement may also contain a clause relating to exit strategy. Investors such as venture capitalists will often look to exit the business they invested in after a certain period of time. The exit strategy clause may outline how long an investor is committed to the business. Likewise, it may outline the conditions under which the investor can sell their shares to a third party in the future. 

Deadlock Resolution

Another common clause that is often included in shareholder agreements are deadlock resolution clauses. These clauses are designed to outline the process if there is a disagreement between investors at the shareholder or director level. Often this process will use a dispute resolution technique such as negotiation or mediation. Negotiation is where both parties will have a discussion in order to come to a resolution. Mediation is similar but involves an independent third party who is there to facilitate the conversation towards a resolution. 

Pre-emptive rights 

Shareholder agreements will often include pre-emptive rights provisions. This means that if the company wants to issue more shares, or any of the shareholders wish to sell their shares, then the existing shareholders will have the first right to buy them proportionate to their current holdings. This ensures all existing shareholders have the option to avoid dilution. If none of the existing shareholders wish to buy the shares, then the company or shareholder (as applicable) is able to go to the market. 

Key Takeaways

Startups often struggle to find outside investors, despite the fact that it is typically one of the best ways for the startup to grow. Between the main two forms of financing — debt and equity – startups often find it easier to raise equity capital. Specialised investors, including angel investors and venture capital funds, inject cash into your startup in exchange for shares in the company. They target businesses with compelling ideas and high growth potential. Startup equity arrangements are often governed by shareholder agreements. These contracts govern the rights and responsibilities the founders owe the investors. These obligations typically enhance the investor’s rights. 

If you need help with startup capital, our experienced corporate lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0800 005 570 or visit our membership page.

Frequently Asked Questions