Getting venture capital can supercharge your business prospects, but it’s also a complex legal matter. There are certain laws you’ll have to be aware of or adhere to if you want the funding to be successful.
In addition, there are certain steps you’ll have to take before investors will even look at your company.
#1) You’ll need to set up a corporation.
Investors won’t invest in an LLC or sole proprietorship. They usually don’t like S-Corps either. A corporation builds value for investors that doesn’t rely on you, personally. Investors also prefer the tax structure of a C-corp.
This is because corporations pay taxes on gross income minus operating expenses, then distribute profits to shareholders. Share holders then only pay income tax on the dividends. Gaining equity in an LLC or S-Corp means taking on a lot more liability.
It’s also easier to sell a C-corp for a profit, which fits nicely into many investment strategies.
#2) You’ll need to make sure your licensing and regulatory compliance are in order.
Are you 100% sure that your new company is fully licensed under New York’s laws and regulations? Are you certain you’re complying with all OSHA, Department of Labor, or industry regulations?
Investors want to know they’re not about to walk into a legal landmine. They’ll want to see that you’re complying with all applicable laws before they move forward.
#3) You’ll need to have your financial house in order.
You’ll need a business plan, and you’ll need to be able to show cash flow. You’ll need profit and loss statements. You’ll need to make sure that you have a corporate account set up and that you’ve never pierced the corporate veil. That your corporate taxes have been paid and accounted for directly.
We recommend hiring an accountant in addition to hiring a business attorney.
#4) There are different ways to invest.
There are two common forms: equity investments and debt investments.
Equity investments give the investor a share in your company, and they receive dividends based on those shares. You’ll want to make sure you understand how to calculate and distribute those dividends.
Debt investments specify fixed payments, with interest, that will go to the investor.
One gives your investor a portion of your company but keeps your company debt-free. The other is essentially a loan, and it comes with all the obligations of any other loan, including paying back that investment.
#5) Investors will want an anti-dilution protection clause.
If you give an investor 30% equity in order to get their money and then start selling a bunch more stock they’re going to want to ensure the total value of their stock always equals thirty percent.
Clauses ensuring that equity will be protected can be worked into your investment contract. They may also be known as anti-dilution clauses, subscription rights, subscription privileges, or preemptive rights.
#6) You’ll need to understand the liquidation preference clause.
What if your company goes out of business? If that’s the case, your investor won’t want to lose everything they sunk into your business. They’ll want to work a clause into your contract which entitles them to receive a portion of the assets when those assets have been liquidated.
The exact amount they’ll be entitled to will depend on how you structure the deal.
#7) Know what you’re agreeing to.
Every investment deal comes with certain obligations. You’ll also “warrant” that certain things are true, such as the fact that you’re operating in accordance with the law and in good faith.
That means you’ll be signing a contract. It will be imperative for you to have someone both negotiate a good deal on your behalf and to explain the deal that you’re being offered to ensure that you understand what you’re signing up for.
Breach your contract, and you could have a very expensive lawsuit on your hands.
Seeking investors? You’ll need to involve a business lawyer.
When you start soliciting investors you’re entering the complex waters of securities law. This law governs everything from the types of people a start-up can seek securities from to what they have to do once they get the money.
Before you seek money, seek help from a business lawyer. From structuring the deal to ensuring that your stocks and equities are set up correctly, a business attorney can be invaluable to ensure that you avoid running into legal trouble once you accept large sums of money.
See also:
6 Contracts Every Business Should Use
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Meet Mr. Richman
SCOTT B. RICHMAN, ESQ.
Mr. Richman is the Managing Member and Founder of Richman Law Firm PLLC. In his role as Managing Member, Mr. Richman oversees the day-to-day operations of the firm and handles the litigation of the most complex legal matters across a vast array of practice areas and disciplines.
