A Legal Guide To Protecting Your Startup While Fundraising
Raising funds is like giving partial custody of your metaphorical baby to another person or company
Lack of a founder’s agreement, employment agreements, and vendor contracts can prove to be harmful to the business in the long run
It’s best to set aside a small portion of your budget and invest in a professional firm to draw the essential contracts
One of the biggest struggles startup founders face while raising funds is deciding when to raise funds. With the growing number of startups in the past few years in India, this has become a looming question.
Most startups look at launching their product, doing a pilot, and then raising funds that will help them pivot to the next stage or scale up to the next level. Fundraises, more often than not, lead to companies giving away a part of their ownership or shareholding to another individual or entity. Therefore, it becomes essential for Indian startups to ensure that they are doing it in a proper and legal manner.
Raising funds is like giving partial custody of your metaphorical baby (your startup) to another person or company. Imagine how careful you’d be while doing so, wouldn’t you?
What Is The Right Time To Raise Funds?
Well, that depends upon your business strategy, vision, and mission. Though the advice that lawyers commonly give to their startup clients is that fundraising should happen only in deals where your venture is being valued appropriately. Irrespective of the stage or the valuation, the most important part of fundraising is the person who has decided to invest in your startup.
What’s Up With The Dilution?
Another important aspect, and perhaps one that comes into the picture at an advanced stage of discussion, is how much should be diluted and at what valuation. In the haste to raise funds, startups make the mistake of accepting terms and conditions which might not be favourable to them in the long run.
One of the most common issues startups face is poorly drafted and loosely worded shareholder agreements, term sheets, and CCDAs. When a venture is in its initial stages, it tends to dilute more for less, give away more rights, and agree to terms it shouldn’t agree with.
Even if a startup is looking to raise investment through friends and family, it is advised to do it through a formal process. A contract should be drawn up to ensure the rights of both the investors and investees in the future.
Set Aside A Budget To Hire Professional Firms
Lack of formally drawn contracts can prove to be disastrous for startups looking to raise money. Startups tend to start off on a trust basis without a proper founders’ agreement. They end up making associations, transactions, and relationships without concrete agreements and without laying down association terms. This can raise the chances of a dispute amongst the founders, employees, vendors, and service providers, among others. Lack of a founder’s agreement, employment agreements, and vendor contracts can prove to be harmful to the business in the long run.
In fact, the trend of ‘copy-pasting’ contracts from the internet is a cause for concern. It’s best to set aside a small portion of your budget and invest in a professional firm to draw the essential contracts. While the lack of proper documentation is a cause for concern for any business, it becomes more of an issue at the due-diligence part of the fundraising process. Investment can also help ‘formalise’ existing associations and business relationships and doing so without a relevant and robust contract can prove to be a bad business move.
Protect Your Brand
In a highly visual and digital world, branding and marketing have become important aspects of all businesses. The struggle starts from choosing the right mark. A lot of companies are tempted to choose common words or logos which are similar to famous ones to gain quick traction and brand value — a sure short misstep.
Startups also tend to forget to protect their carefully chosen, designed, and promoted branding collaterals at the right time. This results in the startups paying a huge penalty for not doing so in time. It’s important to protect your brand name before you secure funds from an investment and spend more time, money, and effort in promoting it.
Intellectual property has become a primary way of building an asset for organisations. Through trademarks, patents, and copyrights, companies can create invaluable assets for their arsenal. This can be used to protect a venture’s software products, hardware devices, innovative methods and processes, content and creative works, designs, etc. and leverage it in the future. It’s important to ensure that your fundraising transactions and agreements are clear regarding the ownership of the intellectual property. Your fundraise contracts too, should mention the same specifically.
Setting the tone right in fundraising is important. While not a strictly legal tip, it is important to understand its importance from a business perspective. Startup founders need to explain their vision, mission and plan to the investors and understand the expectations of the investors as well to ensure that there is no mismatch and issues don’t arise in the future.