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.
Organizing the Company – Choice of Entity
In the first installments of the Bench to Market series, we discussed how to secure and protect intellectual property rights to technology that will be central to the venture. Once the entrepreneur is confident these rights are secure, it is time to form the legal entity that will carry on the business of developing the new technology. It is generally a good idea to create a company early in the process to avoid the necessity of assigning contracts and taking other legal steps that might be required if legal arrangements are made initially in the names of individual entrepreneurs.
It is also important to conduct all business related to the new technology through a company structure so that there is no confusion about who is responsible for the company’s obligations. If a corporation, partnership, or LLC is formed, capitalized, and operated properly, the new legal entity constitutes a separate and distinct “person” for all purposes under the law, and the company, as opposed to the entrepreneur who forms it, will be liable for the debts and obligations of the business. While this is not true in all situations (for example where the owner has personally guaranteed a debt of the company or where the owners have failed to provide appropriate capitalization), the “limited liability” that a separate legal entity provides can and often does prove to be crucial.
