equity financing

How Does Equity Financing Work?

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Posted by Minna Boyle on 1 November 2018

What Is Equity Financing?

Equity financing is where someone invests money in a company in return for shares. There are many types of equity financing – the most common sources for startups and small businesses include:

  • Friends and family
  • Angel Investors
  • Venture Capital
  • Accelerators/ Incubators

Equity financing can provide significant growth opportunities for businesses looking to take the next big step.

Why Use Equity Financing?

As a new business, it can be hard to raise the capital required to achieve your business goals. Banks are often hesitant to lend money to risky ventures, so your only option can be to find an equity investor who believes in your vision at an early stage. Investors agree to provide funding to your company for an agreed valuation, and you can use these funds to finance your business activities. The investors then expect a return on the investment once you’ve been able to grow and reach your potential.

How Do You Do It?

Completing an equity finance deal is a complex legal process. Broadly, there are 4 main steps:

  • Negotiate the key terms – Before everything gets completely finalised, it’s often a good idea to agree on the key terms of the investment in a Term Sheet. A lawyer can help you draft this up so you’re clear about the main points of agreement before moving ahead.
  • Share Subscription Agreement – This is a legally binding agreement where the investor will agree to make payment of funds, in return for shares at the agreed valuation. There are sometimes extra conditions favouring investors, such as:
    • Board appointment rights – often, investors want some oversight and a say over key business decisions, and will ask for a seat on the board of directors.
    • Preference shares – these are shares with additional rights attached e.g. preference shareholders often get favourable anti-dilution and rights on liquidation.
    • Share vesting – this is a mechanism used to incentivise shareholders – usually founders of a startup – to stay with the company. The basic idea is that the founders don’t get their shares until they’ve completed certain milestones and time periods.
  • Shareholders Agreement – This is the document that governs the relationship between the founders and the investors. The basic structure is similar to the one among co-founders, with a few extra clauses that deal with equity investors.
  • ASIC updates – The company’s ASIC register needs to be updated to reflect the new shareholdings and directorships.

Equity Financing Example

Ev has developed a new software to organise email inboxes. Although the software is 100% complete, Ev needs some extra funding for marketing and sales of the product. Ev’s friend, Laura, thinks the software has a lot of potential and offers to invest in the company. Ev agrees to issue 10% of the shares in her company to Laura, in return for $10,000. To give effect to this arrangement, Ev and Laura sign a Share Subscription Agreement. Ev and Laura also sign a Shareholders Agreement setting out their rights and obligations as shareholders. The money from Laura goes into the company and is used for marketing and selling the new software.

Need Help With Equity Financing For Your Business?

Raising capital for your business venture through equity financing can be just the financial boost you need – but putting together a Term Sheet, Share Subscription Agreement and Shareholders Agreement without professional legal advice is a risky move. It can be hard to know everything you need to include and whether you’re getting a good deal. It’s a good idea to invest in a lawyer to assist you with this process, as it’s a one-off cost that can save you from misunderstandings and disputes in the long run.

At sprintlaw, we have a team of experienced lawyers can assist you with drafting or reviewing your Term Sheet, Share Subscription Agreement, Shareholders Agreement or other aspects of the equity financing process. Get in contact with one of our consultants for a no-obligation chat on how we can help you put together an equity financing deal, and help with any other legal issues your business may have.

Need help with Equity Financing?

We can help! Just get in touch and we can walk you through your options.

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Minna Boyle

Minna is the legal operations manager at sprintlaw. After receiving a law degree from Macquarie University and working at a top tier law firm, Minna now manages the legal operations at sprintlaw and puts a focus on making legal knowledge more accessible to the public.
Minna Boyle

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