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Avoid Legal Compliance Pitfalls when Funding Your Business

Securing funding for your business can provide the boost you need to achieve your goals and set you on the path to growth and success. If executed poorly, however, business financing can become a major burden with serious regulatory and personal liability implications. By working with an attorney, you can avoid these pitfalls and ensure that you have a well-documented, effective funding strategy that will benefit your business for the long term. Whether you are bootstrapping, borrowing from friends and family, selling stock, or seeking a loan from a bank or other financial institution, legal counsel will keep you in compliance and help you manage expectations with lenders and investors.

Below, we’ve outlined the main business financing strategies available and some of their major advantages and drawbacks. There’s no one-size-fits-all funding solution, but an attorney can help you assess your needs and pursue the option that best fits your business.

Convertible Notes: Debt to Equity

An effective, widely used means to solicit and raise money, convertible notes are a form of short-term debt. Essentially, investors loan money to a new company and are repaid by converting the amount of their loan, plus accrued interest, into equity in that company. The conversion usually happens upon an agreed upon event, such as once a Series A funding round has been secured, or upon the raising of a certain amount of funds.

Convertible notes offer several advantages to new businesses: they require less paperwork to initiate than other forms of funding, investors are typically not granted board seats on the company (allowing the founders to remain in control), and they don’t involve time-consuming valuation negotiations. There are many different ways to structure convertible note offerings, and each has differing effects on your company’s equity structure and ability to raise additional funds. An attorney can advise you on the most advantageous route for your business.

Raising Funds and Building Publicity With Crowdfunding

Crowdfunding campaigns utilize one of many online platforms to generate interest in your company and raise money. Donation- or rewards-based crowdfunding such as Kickstarter campaigns involve soliciting donations or offering gifts in return for funds, and they’re often used to finance the development of new products. Regulation A crowdfunding involves selling securities, and it must be done through an SEC-registered broker-dealer or funding platform, like Wefunder.

Because it’s a public-facing strategy, crowdfunding allows companies to build awareness of their brand and products. Donation- or reward-based campaigns also allow the founders to retain control (donors are not given shares unless the offering is a Reg A). Crowdfunding is far from a silver bullet solution, however. The publicity and messaging it requires make it a labor-intensive funding strategy, and there are no guarantees for success. Furthermore, Reg A crowdfunding is heavily scrutinized by regulatory agencies and requires detailed financial disclosures and reports. If done incorrectly, it can trigger serious compliance issues with the SEC, so it’s best to work with an attorney to ensure your campaign follows all applicable regulations.

Ordinary Debt: Obtaining a Loan

Ordinary debt is a loan from a bank or online lender. Like rewards-based crowdfunding and convertible notes, loans have the advantage of keeping you in control of your business. However, there are many obligations you will need to meet in order to qualify and other obligations to meet (covenants) while repaying it. It’s vital that you understand these obligations along with all rights and responsibilities upon default—banks may place a lien on your business assets, for example, or you may be personally liable. While the interests of your local or online loan officer are most likely aligned with yours (they want to see your business succeed and their loan repaid), interests can differ over repayment obligations and default scenarios. By working with an attorney as you apply for and obtain a loan, you can ensure that you’re agreeing to fair terms that won’t place an undue burden on you or your business.

Securing Venture Capital and Angel Investments

Venture capital and angel investments involve an outside investor or investment firm funding your business. Usually, this funding is offered in exchange for some share of ownership and control over your company. That can be a disadvantage compared to other forms of funding, but it can also be an asset—investors and VC firms bring valuable experience and knowledge to your business.

As with loan officers, most angels and VCs are willing to invest with you because they see an opportunity. Their interests are aligned with yours when it comes to the overall success of the business but may diverge when it comes to a liquidity event or exit. There are important potential issues to be aware of, such as future equity dilution, the preclusion of other investors, and ultimately the ability to run your business the way you see fit. When considering angel or VC investment, it’s always advisable to work with legal counsel. That way you can ensure that the terms and conditions of the investment benefit your business and further your goals.

SETH KAPLOWITZ
Seth has over 20 years of experience, as an attorney practicing at international law firms and as in-house counsel to an international private equity firm. Seth has advised on, structured and executed commercial transactions throughout North America, Europe, Asia, Africa and South America, both as a legal practitioner as well as an equity and debt holder.
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seth@kaplowitzfirm.com
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