Q: I would like to bring an outside investor into my business. I have heard of venture capital or “VC” firms, but I don’t know much about them. What can a venture capital firm offer my business?
A: For many businesses, fundraising is an essential step toward growth and success. There are a variety of ways to raise capital for your business, including a VC investment.
When starting a business, entrepreneurs often tap their own funds and approach friends and family members for investments or apply for bank loans. They may also try to tap into a network of angel investors, high net worth individuals who invest their own money in emerging businesses. If you are interested in finding an investor who will contribute valuable skills and experience in addition to providing necessary funds, you may want to consider a VC investment.
VCs seek opportunities to invest in high-potential businesses. Think of a VC as a potential business partner with capital to deploy to help your company grow. When a VC investment is made, the VC will get involved in key business decisions and provide strategic and operational guidance to your management team. They can also connect you with other investors, potential clients and other players in your industry.
Once you have identified an investor whose values align with your business goals, stage of growth and funding needs, both you and the investor will conduct due diligence to confirm that the partnership is a good match. You will then negotiate the terms of the investment, which will be memorialized in legal documentation. Many use model legal documents that serve as the industry-standard for venture capital investments. Investors are familiar with such documents and using the forms reduces time spent and expenses incurred negotiating terms.
VC firms will expect to receive equity in your company in exchange for the investment, usually in the form of preferred stock. Preferred stock affords investors preferential rights. Preferential rights commonly include board representation, dividend preferences over holders of common stock, anti-dilution protections to ensure that their equity stake is not diluted by further equity issuances, a right of first offer to invest in later fundraising rounds and liquidation preferences that ensure their capital is returned before distributions are made to common stock holders, in the event of the sale of the company.
Bringing an outside investor into your company has many implications for your business. When considering a VC investment, it is essential to consult with experienced legal and financial professionals to ensure that the investment process is conducted properly and that you make the best decision for your company.
Know the Law is a bi-weekly column sponsored by McLane Middleton. Questions and ideas for future columns should be emailed to knowthelaw@mclane.com. Know the Law provides general legal information, not legal advice. We recommend that you consult a lawyer for guidance specific to your particular situation.