Raising capital can be an exciting milestone for a growing business. An investor believes in what you are building, and suddenly you have the money you need to hire employees, open another location, purchase equipment, or expand into a new market. But there is an important distinction between getting an investment and taking someone’s money.
When you raise capital, you are entering into a legal relationship with an investor. The structure of that relationship can affect your ownership, decision-making authority, future fundraising, and even your personal liability. Before accepting a check, it is worth understanding the legal side of raising capital.
What Does Raising Capital Mean for a Business?
Business owners can raise capital in different ways. A company might bring in an equity investor, borrow money, issue a convertible security, or structure another type of investment. The important question is not simply, “How much money are we raising?” But it is also, “What is the investor receiving in exchange for that money?”
An investor may receive an ownership interest, repayment rights, voting rights, preferred rights, or other contractual protections. Those rights should be clearly defined before money changes hands.
Do I Need a Lawyer to Raise Money for My Business?
There is no rule that says every business must hire a lawyer before raising capital, but raising money can create legal obligations that are easy for business owners to underestimate.
Securities laws can apply when a company offers an ownership interest or certain investment arrangements. Depending on how the offering is structured, the company may need to register the offering or rely on an available exemption.
That means the legal structure should be considered before you start soliciting investors, not after the investment has already been accepted.
What Legal Documents Do You Need to Raise Capital?
The documents depend on how the investment is structured. For an equity investment, the transaction may involve documents such as a term sheet, subscription agreement, investor representations, amended operating or shareholder agreements, and other corporate records.
The purpose of these documents is not simply to make the transaction look official. They establish exactly what the investor is receiving and what everyone agreed to. A handshake understanding that an investor will “get 10%” can become a serious problem when the business becomes more valuable and the parties remember the deal differently.
How Much Ownership Should I Give an Investor?
This is one of the most important questions in raising capital. Giving an investor 20% of your company does not simply mean giving away 20% of today’s business. That ownership can affect future financing, distributions, voting rights, and the value of the founder’s remaining interest.
Business owners should consider both valuation and control before agreeing to an ownership percentage. An investment that solves today’s cash-flow problem could create a much larger ownership or governance problem later if the deal is poorly structured.
What Rights Can Investors Ask For?
Investors may negotiate for rights beyond basic ownership.
Depending on the transaction, those rights could address:
- Voting and management decisions
- Information and financial reporting
- Future financing
- Transfers of ownership interests
- Distributions
- Sale of the company
- Protection against dilution
These provisions can become particularly important as a company grows.
For example, an investor who owns a minority interest may still have significant influence if the investment documents give that investor approval rights over certain major business decisions.
What Is Due Diligence When Raising Capital?
Investors typically want to understand what they are investing in before committing their money. That can involve reviewing the company’s financial information, contracts, ownership structure, intellectual property, liabilities, litigation, employees, and other important business records.
Business owners should be prepared for this process. More importantly, the information provided to investors needs to be accurate and complete. Statements about the company’s finances, operations, ownership, or future prospects can have legal consequences.
What Can Go Wrong When Raising Capital?
Many capital-raising problems do not begin with a bad investment, but with a poorly documented one. Common problems include promising ownership that was never properly documented, failing to clearly define investor rights, overlooking securities-law requirements, or creating an agreement that conflicts with the company’s existing operating or shareholder agreements.
Once multiple investors, significant amounts of money, and competing expectations are involved, fixing these problems can become considerably more expensive.
How Can a Business Lawyer Help With Raising Capital?
The best time to address the legal side of raising capital is before the deal is finalized. A business lawyer can help evaluate the proposed investment structure, review or prepare the necessary agreements, identify potential securities-law issues, and make sure the transaction fits with the company’s existing ownership and governance documents.
Capital should help your business move forward, not create a legal problem that follows you into its next stage of growth.
If you are raising capital, bringing on an investor, or negotiating the terms of a business investment, please don’t hesitate to contact one of our experienced attorneys at 305-570-2208.
You can also contact our team directly at: arianna@ayalalawpa.com
Schedule a case evaluation online here.
[The opinions in this blog are not intended to be legal advice. You should consult with an attorney about the particulars of your case].
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