Securing venture capital (VC) is a big step for many Australian startups. For founders, VC funding can provide the cash injection needed to scale, innovate, and enter new markets. But raising venture capital in Australia is not as simple as signing a cheque and moving forward. It requires an understanding of legal steps, investor expectations, and the responsibilities that come with outside investment. In this article, we’ll guide you through the essential legal considerations for raising venture capital in Australia.
What Is Venture Capital, and Why Do Startups Seek It?
Understanding Venture Capital
Venture capital is a type of funding provided by investors who specialise in high-growth businesses. These investors, often called “venture capitalists,” provide funding in exchange for equity (ownership) in the company. For startups, venture capital offers a way to grow quickly, often without taking on debt. The catch? Venture capitalists usually seek a share of control in the business, along with the potential for high returns on their investment.
Key Legal Considerations When Raising Venture Capital in Australia
Before diving into the VC process, it’s essential to understand the legal landscape around it. Raising venture capital in Australia involves specific legalities, documents, and negotiations that can shape your business’s future.
1. Structuring Your Company for Investment
The structure of your business plays a significant role in attracting venture capital. Most venture capitalists prefer to invest in companies structured as a proprietary limited company (Pty Ltd), as it’s straightforward and allows for multiple shareholders. Setting up a proprietary limited company allows you to issue shares to investors, which simplifies the investment process.
Why Pty Ltd Companies Are Preferred by Investors
A proprietary limited (Pty Ltd) structure is common among startups raising venture capital because it allows for a straightforward ownership model. It also offers limited liability protection, which means that investors are not personally liable for the company’s debts. If your business isn’t already structured as a Pty Ltd, it’s worth consulting a lawyer to ensure your structure is VC-friendly.
2. Understanding Term Sheets and Negotiations
A term sheet is an outline of the investment terms that both you and the investor agree upon before finalising the deal. It’s one of the first steps in the VC process and covers important aspects such as valuation, share ownership, and investor rights. While a term sheet is not legally binding, it sets the tone for the investment relationship and the final legal agreements.
Key Clauses to Watch For in Term Sheets
- Valuation: This is the agreed-upon value of your company, which affects the percentage of equity you’ll be giving to investors.
- Board Control and Voting Rights: Venture capitalists may request seats on your board of directors, giving them some level of control over major business decisions.
- Liquidation Preferences: This determines how investors will get paid if your business is liquidated, often giving them priority over founders.
Understanding these clauses and negotiating terms that protect your interests is critical. It’s advisable to work with a legal professional who can ensure the term sheet is fair and balanced.
3. Shareholders Agreements and Protecting Founders’ Rights
When investors come on board, a shareholders agreement outlines the rights and responsibilities of all shareholders, including founders and venture capitalists. This document helps avoid conflicts by defining key terms around share distribution, decision-making, and exit strategies.
Why a Shareholders Agreement Matters
A well-drafted shareholders agreement protects founders from losing control and sets clear guidelines on how the business should be run. Here are some important elements to consider:
- Founder Vesting: Ensures that founders who leave early do not take a significant share with them, protecting the remaining founders and investors.
- Exit Clauses: These include rights such as “drag-along” and “tag-along” clauses that manage how shares are sold if a shareholder wants to leave or if the business is sold.
- Anti-Dilution Protection: This helps protect investors from having their shares diluted if the company issues more shares in future funding rounds.
4. Legal Due Diligence: What Investors Will Check
Due diligence is a thorough review process conducted by investors to assess the viability of your business. Investors will examine everything from your financial records to intellectual property rights to assess the risks of investing.
Areas of Focus in Due Diligence
- Financial Health: Investors will look into financial statements, revenue, debts, and any outstanding liabilities.
- Intellectual Property (IP): If your business relies on unique technology or a brand, protecting your IP is crucial. Make sure you own the IP, and if necessary, file for patents or trademarks.
- Compliance: Investors will want to ensure that your company complies with all regulatory requirements, including tax obligations and employee contracts.
Completing these checks and preparing necessary documents can make your business more attractive to venture capitalists and speed up the investment process.
5. Preparing for the Long-Term: Investor Relations and Reporting
Raising venture capital isn’t a one-time transaction. Once investors are on board, they’ll expect updates on your company’s progress and may be involved in strategic decisions. Building a solid relationship with your investors from day one will make future rounds of funding easier and create a collaborative working environment.
Best Practices for Investor Relations
- Regular Updates: Keep investors informed about your achievements, challenges, and plans. Quarterly reports are common, but some investors may prefer more frequent communication.
- Transparency: Be open about the business’s performance, including any setbacks. Honesty goes a long way in building trust with your investors.
- Engagement: Many investors bring valuable expertise and connections. Engaging with them can provide insights, especially during challenging times.
Key Agreements and Contracts for Raising Venture Capital in Australia
When seeking venture capital, having the right agreements in place is crucial to protect your business and ensure a clear understanding between all parties involved. Here’s a list of essential contracts:
- Term Sheet
- Outlines the preliminary terms of the investment, including valuation, share ownership, and investor rights. Sets the groundwork for final agreements.
- Shareholders Agreement
- Defines the rights and responsibilities of shareholders, including voting rights, decision-making processes, and exit strategies. Important for protecting founders’ rights.
- Subscription Agreement
- Details the terms under which investors will purchase shares in your company. This agreement specifies the investment amount and number of shares issued.
- Employment Contracts
- Essential for securing key team members and outlining terms like salaries, leaves, and IP ownership. Employment contracts should be reviewed before funding rounds, as investors may want to assess the stability of your team.
- Intellectual Property Assignment Agreement
- Ensures that any intellectual property developed by employees or contractors is owned by the company, not the individual creators. This is particularly important in tech startups.
- Non-Disclosure Agreement (NDA)
- Protects confidential information shared during discussions with potential investors or partners. An NDA helps prevent sensitive business information from being leaked.
- Option or Equity Incentive Plan
- If offering equity to employees, this plan outlines the terms for stock options, including vesting schedules and eligibility criteria. It’s an attractive incentive for talent and is often reviewed by investors.
- Convertible Note Agreement (if applicable)
- If your business is raising initial funding via convertible notes (a form of debt that converts into equity), this agreement outlines the terms for conversion, interest rates, and maturity dates.
Final Thoughts: Seek Legal Advice When Raising Venture Capital in Australia
Raising venture capital in Australia is an exciting but complex journey. Understanding the legal steps and considerations can save you from future headaches and help ensure a successful relationship with your investors. Working with legal experts who understand the Australian startup scene can make a significant difference, ensuring that your business is set up for growth and protected from common pitfalls.
