A common way to fund a new business concept is to raise Capital by approaching family, friends or funders. In fact, it may be the only way to obtain funding on reasonable terms, either because you have no credit history, the business model is completely untested, or you want to maintain confidentiality about your business.
As a founder you may invest in your own business. This might be through a lump sum (savings) or by reducing the payments as salary you draw from the business for a period of time – that is, you pay yourself last.
Furthermore, if your business is initially dependent on you, it will need to have access to working capital in case you face a major health issue, such as a heart attack. Make sure you document correctly all funds you have invested in your business.
What follows is an overview of the current legal framework in respect to capital raising and the risks associated with it.
The Corporations Act 2001 (Cth) (Corporations Act) regulates capital raising. The Corporations Act imposes strict disclosure requirements on companies raising capital.
For private companies, however, there are exemptions to these requirements.
If you are offering shares to the public, you will be exempt from the formal disclosure requirements if:
- You made a personal offer to someone likely to be interested in the offer, and you only intended that person to accept the offer; and
- You made the offer to less than 20 people in a 12-month period; and
- Your offer will not result in the company raising more than $2 million in a 12-month period.
These exemptions mean that a start-up raising $2 million or less in a 12-month period from less than 20 entities should not have to go to the trouble of preparing formal disclosure documents. A pitch deck (and if required, an information memorandum) should suffice. It is crucial, however, that your pitch deck is accurate, truthful and not misleading or deceptive. You should include an appropriately drafted legal disclaimers and have a qualified accountant review your financials.
Risks Attaching to Funding
There are several risks attaching to funding, such as:
- Business failure and the risk that a close associate (Friend, Family or Funder) may lose money
- Lack of commercial understanding or dealings at arm’s length
- Lack of formalities
If you have another source of finance, try to avoid funding from a close associate. While you may have to give more equity away or pay more interest to a third-party investor, at least you avoid being dependent on close associates. Avoid borrowing a large amount from a close associate. Only accept their money if you know they would not be affected if something happened and you could not give them back their money.
To minimise the risks associated with sourcing finance from close associates:
- Disclose – fully disclose all details about your business. Give the potential investor a copy of your business plan and ensure they understand all the risks involved with the business, including all external and internal risks, especially the untested nature of the products or business.
- Explain – explain that its difficult to value a new business. Also be aware that your family and friends will probably fall into the category of ‘unsophisticated investor’ and may not know how to value your business.
- Set realistic expectations – make sure you talk openly and frankly about your expectations for the business; when and how you will repay the money, what happens if the business fails and any liability that may arise. Also discuss the ways that you will act at arm’s length (and not as a ‘mate’, friend or family) between the investor and the business.
- Observe formalities – have a solicitor prepare a short-form agreement outlining the funding requirements between you and any other parties, include the following:
- Amount being invested
- When the money will be repaid
- Whether the investment accrues interest or dividends and the rate of return
- The rights attaching to the investment
- What happens when you want to sell the business
- A dispute-resolution provision that details how you will deal with a breach of the agreement
- Beware of the fool – the fool as an investor in your business is more prevalent than you may think. The fool is a person who takes little interest in the detail of an Offer, operates on selective memory about the Offer and wants to control your venture.
If you require assistance and legal advice in respect to capital raising for your new business venture, our experienced Solicitors at Pavuk Legal would be pleased to assist you. Feel free to contact our office to speak with one of our friendly solicitors today.