Raising Private Capital Redux
Now that you’ve decided to raise private capital, what’s your next move? How do you go about finding and signing up investors for your business?
Unfortunately, fundraising is a difficult, frustrating and lengthy process for most entrepreneurs. The path to financing does not end with a strong patented technology, a solid business plan and model, and an experienced and talented management team. Of course, a company that lacks any of these things likely will go unfunded. But in most situations, even a well positioned company needs the requisite relationships to make a financing happen, and it must navigate cumbersome federal and state securities laws to ensure it remains legally compliant.
Before an entrepreneur hits the road looking for money, he or she should be familiar with some basic legal principles applicable to raising capital. A new company must be cautious and thoughtful when seeking investments. As we explained in our earlier post on Raising Private Capital, every offering of securities must comply with the registration requirements of federal and state securities laws or qualify for an exemption from these requirements. Many companies structure private equity investments to comply with the Rule 506 exemption promulgated under Regulation D of the Securities Act of 1933, because it is the only federal exemption that preempts state securities laws and allows a company to raise unlimited amounts of money. As a result, it is a very attractive exemption without many of the restrictions and limitations imposed by other exemptions.
The Rule 506 exemption, however, limits both the universe of potential investors that a company may target and the means by which it may reach these investors. First, securities may not be sold using general solicitations or advertising, including through newspapers, magazines, mass mailings and media broadcasts or at seminars or similar events. A company and its agents may solicit an investment only from a person with whom they have a “pre-existing, substantive relationship,” which the rules define as a relationship established prior to the offering and of sufficient quality that the company reasonably believes the offeree has adequate financial sophistication, experience and expertise to properly evaluate the risks and merits of the investment. Second, a company should solicit investments only from “accredited investors” that satisfy certain income, net worth or asset tests. If non-accredited investors are included in the offering, the company faces substantial and burdensome disclosure requirements that make compliance both difficult and costly.
Once you have a solid grasp of the legal framework, it is important to understand how much capital you require both initially and over time, and how this capital will be used in the business. This will affect your potential sources of financing and will drive your fundraising efforts. Smaller amounts of capital (e.g., under $150,000) typically can be pieced together through friends, family and grants. After this “seed” capital, companies often look for additional funding from “angel” investors (i.e., high net worth individuals). If the company will be capital intensive, either at commencement or at some point in its early development, it may require financing from venture capital funds, which typically have minimum investment amounts (e.g., $1 million – $2.5 million). These are the typical investor categories for a start-up business, but every company is different and may attract capital from a variety of alternative sources. Please remember that the same securities laws apply whether you’re asking your neighbor for a $15,000 loan, looking for $500,000 from a local angel network, or soliciting $10 million from a syndicate of venture capital funds.
The bottom line: raising capital requires a strong network for both legal and business reasons. But how does an entrepreneur establish such a network? A good place to start is by forming a relationship with an attorney, accountant, consultant or other service provider who has experience and expertise in your industry. These professionals may be able to put you in touch with others who can assist your company either operationally or financially. A good service provider can help you refine your business plan, build a management team, identify potential investors and advisory board members, introduce you to strategic partners and, potentially, help you locate investment bankers or placement agents for larger capital raises.
You should consult with other executives, entrepreneurs, scientists and academics in your field or industry for advice and referrals. You should also understand and become involved in your local business community. If you are a part of or near a research university, pay a visit to its technology transfer office and seek advice. In North Carolina, for example, in addition to strong research institutions there are active trade organizations (e.g., Council for Entrepreneurial Development, NC Biosciences Organization), incubators (UNC’s “Launching the Venture,” First Flight Venture Center, the Triangle Startup Factory), quasi-government agencies (e.g., the North Carolina Board of Science & Technology, the North Carolina Biotechnology Center), and other groups (e.g., the North Carolina Small Business and Technology Development Center) whose mission is to commercialize science and technology and encourage entrepreneurship. They actively mentor young companies and provide helpful resources. You simply must get involved and meet people. A financing can arise from an unlikely source, and so never underestimate the contacts and referrals that your involvement will generate.
