You’ve got a great idea and a dream. You’re ready to start your new business. But before you can reach the sky, you need the funds to get off the ground.
Raising money is one of the biggest and most common hurdles that entrepreneurs face. In fact, a huge number of businesses rely on “bootstrapping”—using the founder’s savings to get started. In many cases, this money can only go so far. Plus, this involves a lot of personal risk.
Luckily, there are many sources of capital to fund startup and small businesses. Bootstrapping is one of those options, which also include:
- Small business loans
- Equity investors and fundraising
- U.S. government loans and SBA funding programs
The problem with so many options? Each comes with financial and legal issues and risks you must consider, ideally with the help of a lawyer.
The decisions you make at the beginning can make or break your startup, especially in competitive markets like San Francisco Bay Area’s Silicon Valley.
Debt vs. Equity for Financing a Startup
You can structure your business financing in two ways: debt or equity.
- Debt has to be paid back, equity does not.
- Equity dilutes your ownership in your business. The more your investors own, the less you keep.
- Convertible financing combines both debt and equity.
With debt financing, you take out a loan and repay the money later, usually with interest. You keep ownership and control of your business and its profits. Debt includes bank loans or personal loans from family or friends that you’re expected to pay back.
With equity financing, you sell shares or ownership in your business in exchange for capital. You generally don’t pay back the investment. However, you share your business profits or even control of the business with your investors.
With convertible financing, you issue a loan that converts to equity when there is a triggering event. The triggering event is typically when you get your next round of financing that meets certain requirements.
Whether you choose debt, equity, or a combination depends on your situation and goals. It’s important to weigh the risks of each and to choose a lawyer who specializes in startups.
Getting a Loan for a Startup Business
A small business loan is one way to raise money without giving up equity in your business. Unfortunately, new business loans are risky for traditional lenders like banks. That’s because you don’t have a history of profits (yet!) to prove your credit.
You may consider a personal loan or a mortgage on your house. That could work but it hits a little too close to home.
Now’s a good time to make sure you’ve considered all your options, such as government or unsecured loans. A startup attorney knows where to look and can guide you in the process.
Government Loans for New Businesses
The U.S. Small Business Administration (SBA) partners with banks and other lenders to fund startups that may not qualify for other loans. Through this program, the government offers a percentage guarantee of the loan, absorbing the risk of default.
SBA loans have lower interest rates and different requirements compared to other loans. The SBA has several programs to choose from, including 7(a) loans, CDC/504 loans, and the SBA microloan program.
The SBA also offers specialized loan programs that could apply to your business. A small business lawyer will have the expertise to find the program that’s right for you.
Personal Loans from Friends and Family
You may have a relative or friend willing to put down money on your business. Great—except talking money with those closest to you can be difficult. Do they expect to be paid back in some way or is their contribution a gift?
A contract may seem unnecessary, but setting your expectations in writing now can save you trouble later.
Depending on how you go about it, taking money from friends or family could have securities law implications. Talk to a business lawyer to set up the proper contracts, promissory notes, and business structure for the transaction. Doing so will help protect your interests, your relationships, and keep you on the right side of the law.
How to Raise Equity Capital for a Small Business
Equity fundraising is a popular option for startups because there’s no interest and you don’t have to pay back the investment. Instead, an investor provides capital in exchange for ownership or control rights in the company, such as board seats or voting powers.
Common sources of equity include angel investors, private equity funds, and venture capital funds. Because equity usually means sharing control of your company, focus on investors and firms who specialize in your kind of startup.
The right equity partners could:
- Infuse your new business with the capital it needs
- Connect your small business to a larger network
- Increase your startup’s reputation in the industry
You’ll probably be working with your investors for a while, so it’s important to find people who believe in your vision.
How to Structure a Deal with Investors
Equity financing is common, especially in the Bay Area. The process of putting together a deal is complex, with many variables and interests at stake. Your small business must have the correct formation. You must also follow U.S. securities laws to bring on equity investors.
Make sure your business is the right type for certain loan and equity requirements. Investment structures will change based on whether you’re a sole proprietor, partnership, LLC, or corporation.
U.S. Securities Laws
The U.S. Securities and Exchange Commission (SEC) regulates securities to protect investors at the federal level. States also have their own laws for protecting investors.
Corporate stock is a common type of security. However, securities are more broadly defined than you might think. A membership interest in an LLC could also be a security.
Consequences apply any time you issue securities to investors, founders, contractors, or employees. The legal requirements of a simple transaction may be greater than you expect. Going afoul of securities laws could mean costly fixes down the line, fines, or even prison time.
This is a crucial time for your startup. You’re building the foundation for the future of your business. Your lawyer’s expertise is there to guide you to long-term success.
Other Challenges Faced by Entrepreneurs
Hiring the right lawyer for your startup will continue to pay off as your business grows. Financing and business formation are just parts of an equation that also includes:
- Contract drafting to shield you and your business from liability
- Registering and protecting your intellectual property
- Identifying where your business needs insurance
- Handling employment agreements and tax requirements
Coepio Legal specializes in legal advice for startups and small businesses, especially in the competitive San Francisco market. Entrepreneurship is an exciting and challenging time—simplify the process with our firm at your side.
Call our office today at 415-289-5149 and let’s get started.