Company & Commercial - Protecting your interests when taking venture capital
Updated: Jan 31, 2020
Legal Advice for Small Businesses Seeking Funding from Venture Capitalists
Legal Advice for Small Businesses: Taking funding from venture capital capitalists is a tempting option when trying to get a business off the ground, but caution is recommended - as is getting legal advice. Here is why getting this advice is important.
Venture Capital Funders to the Rescue - or Not?
The stories of individuals and companies receiving investment after appearances on TV’s famous Dragon’s Den show are legendary, but occasionally someone turns down the chance to work with famous investors.
This was, for example, the case when the founders of “The Great British Porridge Company” turned down Tej Lalvani’s offer of investing £60,000 in their business in return for 22 per cent thereof.
After appearing on Dragon’s Den in 2018, the two directors initially accepted this offer but changed their minds later, when they described the proposed investment arrangement as ‘very restrictive’.
Protecting Your Interests when Taking Venture Capital
Whether you have a brilliant business idea and need funding to get started or need a substantial capital injection to grow an already trading business, a venture capitalist investment may look like an appealing solution.
There are, however, two significant issues you should consider:
1. You do have other options that may be more suitable for your business, and
2. If you are set on pursuing venture capital, you should ensure that you know exactly what the medium/long term consequences of doing so will be.
Likening venture capital funding to taking valuables to pawnbrokers in that it provides you with fast cash but will also incur significant cost, corporate & commercial solicitor Richard Turney of Rose& Rose Solicitors says:
“While venture capital companies take minority stakes in businesses, their eyes are set on their eventual exit right from the beginning. Typically looking to retain their investments for 5 to10 years, they will at that point either offer the business on the stock market, acquire it or sell it. “
Different VC Investment Stages
Whether venture capital is suitable depends on where within the business lifecycle your company is:
· Seed financing enables development of a business and may be used for the purpose of research and development and/or production of a prototype;
· Start-up financing can be used for a product’s development and initial marketing thereof;
· Other early-stage funding could assist a growing but not yet profitable company with manufacture and sales;
· Late stage VC funding may be offered to a company that has stable growth but is not growing as rapidly as predicted yet; and
· Other VC financing may be given to assist expansion of a company that is already profitable.
Advantages of VC Investments
The fact that money is provided not as a loan but in an exchange for equity is a key venture capital advantage, as you will not have to worry about making repayments or the ultimate cost of borrowing.
What’s more, good VC investors play active roles in your business and bring valuable experience and skills to ‘the table’. They are frequently also experts in recognising and analysing opportunities and can help you maximise your business’ future outcome. The right investor may also have useful connections across a network they can readily access on your behalf.
VC Funding Pitfalls
It is imperative for you to approach any external investment with caution. It is undoubtedly flattering that someone is not only willing to lend you money but appears to both share your vision and be willing to take a chance – they are, after all, effectively betting on your efforts. This does, however, not necessarily mean that you/your business must always take such an offer.
Investors will, in return for their investment, expect you to sign a legally binding agreement giving part of your company/business away, as well as imposing diverse restrictions. They will also require guarantees and indemnities, especially if your start-up has no assets or trading history. Before talking to venture capitalists, it is therefore imperative to consult your solicitor concerning the required type of security.
If you make a profit, you will be giving part of it away, and the VC investor will have a say in any key company decisions you make. Taking your autonomy away, this means you must consult with your investors to get their consent before you can make any major changes, which may cost you the ability to shape and reshape your business in the years to come. Due to the need to consult with more people, making decisions also almost inevitably takes longer.
The expertise you obtain may also not necessarily be quite what you hoped for. Some VC investors prefer to stay in the background, while others may appear too interfering, and some investors may have expectations that are far too high, which can leave everyone involved disappointed with the agreement.
What’s more, you will always be accountable to your VC investors, which could leave you tailoring your business to what they want, as opposed to what you feel is right for it. You will also be expected to continually prove your worth by regularly spending a great deal of time creating progress reports.
One of the main things to consider long term is that in time, the people who oversee your company may change. As your small company becomes medium-sized, you may, for example, decide to move on and remove one of your directors. But what happens if this director signed a guarantee? Can you see your way out of this dilemma?
If your company is doing exceedingly well, you may want to repay the money. While this is usually an option, this can, however, cost you significantly.
Legal Advice for Small Businesses
Although obtaining capital via the usual routes may be somewhat painful in short terms, it could well save your business in longer terms.
Ordinarily, venture capital investments are pursued after the usual funding routes were refused. Working with successful, experienced investors could give you the ability to tap into their experience and industry knowledge – but this may not always be the case. Providing guarantees will also be required, and the redemption cost could be significant.
When considering VC funding for your business, it is therefore crucial to seek advice from legal specialists concerning the money borrowing terms of the investment agreement and to what extent your investor will support you under this agreement.
For more detailed information, please do not hesitate to contact Richard Turney by calling us on 020 8974 7490 or dropping us an email at firstname.lastname@example.org.
Please Note: This article does not constitute professional or legal advice and is only for general information. It is possible that laws may have been changed since publication of this article.