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How startups can successfully execute their first capital raise
30 August 2022 | Minutes to read: 5

How startups can successfully execute their first capital raise

By Alex Zinzopoulos and Mark Calvetti

Undertaking a capital raise is complex and often daunting. It requires time and planning. If you’re considering launching a capital raise, particularly if it’s your first, read on for tips from our experts on what to expect and practical steps that could improve the outcome.

Runway

To ensure your startup can keep trading until funds are raised, you must determine its ‘runway’. A runway is the length of time your business can operate before it exhausts capital, which is crucial in determining when to begin your capital raise.

Importantly, founders should commence the capital raise well before the funds are needed, as a capital raise can take anywhere from three months to as long as twelve months in more complicated scenarios, and is very dependent on market conditions.

Which investor is right for you?

Once you have determined the amount of capital required, it’s important to identify the most appropriate source of capital for your business requirements. The type of investor you choose will depend on the amount you are looking to raise, the maturity of the business and the timing of an exit, among other factors.

The three most common types of investors for startups are:

  • Venture Capital (and Private Equity) firms
    Venture Capitalist (VC) firms provide capital to early-stage businesses with high-growth potential in exchange for an equity stake and some operational control. VC’s tend to invest at the Series A+ funding rounds and the length of time they choose to hold an asset will depend on their strategic objectives and composition of their portfolio. Private Equity firms (PE) operate in a similar way however generally tend to invest in mature businesses with a proven track record rather than early-stage businesses.
  • Angel Investors
    Angel investors are individuals who provide financial backing to early-stage startups in exchange for equity in the company. In contrast to VCs and PEs, angel investors are more passive investors and typically provide seed funding, prior to a Series A raise.
  • Family Offices 
    A Family Office or Private Office is a family-owned and controlled structure that manages private wealth and other matters for high net-worth families. Family offices often make longer term investments in startups and high-growth businesses.

In choosing which type of investor to partner with, you will need to consider how much equity and operational control you are willing to divest. Choosing an investor that shares your values and goals is also critical.

Setting up your corporate structure

Choosing the appropriate structure for your business is a crucial step that needs to be done prior to starting the capital raise process. The corporate structure you implement will have various flow-on effects for asset protection, tax liabilities and laying the groundwork for international expansion or a future exit. When raising capital, you also need to consider which corporate structure is most suitable to your investors. Trying to change the corporate structure after a capital raise is difficult and not ideal, particularly once your investors are already on board and there is a market value now attached to the business. Read our top five tips for structuring and restructuring your startup here.

Getting your business valuation right

The lack of information on a startup’s past performance can make it difficult to value, and in turn affect the willingness of individuals or groups to invest. It is important that you establish a clear business plan that includes a financial model with all relevant assumptions underpinning the business. This will enable an investor to understand the business model and growth potential.

Attracting investors

Finding the appropriate investor for your business can be difficult, so you need to think like an investor. Some questions to ask yourself are:

  1. Can I clearly and succinctly articulate my startup’s value proposition?
  2. What is my go-to-market strategy?
  3. How is my product different to what’s currently available?
  4. How and when will I get a return on investment?
  5. Do I have an ESOP in place to retain and incentivise staff?
  6. Am I making the most of government grants or the Research and Development Tax Incentive?
  7. What is my exit strategy, and will an exit occur in Australia, New Zealand or overseas?

These questions would typically be answered in your pitch deck. A successful pitch deck goes through the fundamentals of the startup as it scales towards an exit. Typical items investors expect to see in a pitch deck include:

  • Business model
  • Go-to-Market plan
  • Competitor analysis
  • Management team
  • Financial projections and key metrics (financial model)
  • Business valuation
  • Accomplishments to date
  • Timeline of key business goals, and
  • Runway and use of funds.

For more on how to stand out from the crowd and attract investors, read Six ways to make yourself a VC magnet.

Structuring and capital raise

Once the startup and investor have agreed to work together, the next decision is what type of investment instrument to issue. Besides ordinary shares, the most used instruments issued by startups undertaking their first raise tend to be Convertible Notes, SAFE Notes and KISS Notes.

  • Convertible notes (con notes)
    Convertible notes are debt instruments (i.e. they have an interest rate and an obligation to repay the debt) but also come with an ability to convert into equity at a future equity round. The conversion typically occurs at a discount to the price per share of the future round, usually around 10%.
  • Simple Agreements for Future Equity (SAFE)
    SAFE notes are similar to convertible notes in that they convert to equity at a future round. However, they are not a debt instrument, so there is no requirement for the startup to repay the investor if there is no future funding round. Since there is greater risk for the investor, the discount for SAFE notes tends to be higher, between 15-25%, and may work in conjunction with a valuation cap (the maximum amount per share the investor is required to pay for the shares upon conversion).
  • Keep It Simple Security (KISS)
    This is an alternative funding instrument to SAFE notes that has gained popularity in recent years, particularly in the U.S. Like a SAFE, a KISS converts to shares at a future point in time, but KISS notes tend to have more investor-favoured terms such as participation rights in future funding rounds on terms comparable with prior investors via a most favoured nation (MNF) clause.

For more on how to best structure your pre-IPO capital raise, with Con notes, Shares or SAFE notes, read our article here.

In our experience, SAFE notes have been the most common type of funding instrument used by startups in Australia in recent years. An additional benefit of using SAFE Notes (as well as KISS and Con notes) is that a valuation of the startup at the time of investment is usually not needed since shares are not being issued until a future funding round.

Once VCs and PEs come on board (typically in Series A+ rounds), you can expect to issue preference shares. As the name suggests, preference shares provide their holders with preferential rights to other shareholders such as anti-dilution, right of first refusal, drag-along rights and priority rights to dividends and capital returns.

Which type of funding instrument is right for you will depend on the circumstances of your startup and the investors you are looking to work with.

If you would like more information on raising capital for your startup and how we can assist by sourcing investors and leading the raise, please contact your local William Buck Corporate Advisor.

How startups can successfully execute their first capital raise

Alex Zinzopoulos

Alex is a Principal in our Tax Services division. He has built his experience working with a range of private and public companies in the tech sector, including SaaS, Blockchain and NFTs, Fintech, Data Science, Biotech, AR/VR, Regtech, Cleantech, IoT and Advanced Manufacturing.

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How startups can successfully execute their first capital raise

Mark Calvetti

Mark is a director of the Corporate Advisory division advising clients from a broad range of sectors on a variety of corporate advisory elements. Working with both private and public companies, Mark assists with acquisitions and disposals, capital restructuring advice (debt and equity), mergers and takeovers, IPOs, valuation and due diligence.

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