Legal matters in Seed Funding

By Helen Mather, Partner.

Seed funding can be instrumental in taking a product or service from an idea to a tangible, marketable result, but can also create more complications than anticipated.

Seed funding primarily comes in the following forms:

1. Equity Finance – trading ownership in the Company (shares) for capital,
2. Debt Finance – receiving capital by way of a loan; or
3. Crowd funding – Funding from groups interested in your idea; this is often utilised at a very early stage of product development.

Equity finance can involve a diverse range of investors, such as:

1. ‘Angel’ investors – Wealthy individuals who seek to fund a project they see potential in from early in its life. These investors often have relevant industry experience and so may seek to become directors or advisors in return.
2. Venture Capital funds – usually not as early in their funding as angel investors. Promising startups can often attract multiple funds with minority stakes as opposed to one more controlling angel investor. These funds often have industry connections and can give guidance based on their experience and portfolio.
3. Friends and Family – Not to be forgotten, these potential investors may be more trusting in your potential than other institutional investors.

Securing funding however is not as simple as taking the money, and having an experienced lawyer on your side can be helpful in both securing this funding on the best possible terms and ensuring it isn’t wasted.

Issues to be considered and which your lawyers can help you navigate include:

1. Advantageous Corporate Structures

The ownership structure of the business can be vital to ensuring seed funding is used effectively. A holding company structure for example can allow a startup to protect its intellectual property rights such as trademarks and patent applications while continuing to trade and develop its product in the trading company.

2. Ownership

As part of the seed funding process, lawyers can negotiate the terms and reflect in the legal documents provisions that ensure your share ownership structure creates a balance between enticing investors who want equity and pleasing the founder(s) wishing to remain at the head of the company, to see their vision realised (and that they have a suitable share of the profits and capital returns as the fruits of their labour when it is realised).

Long term ownership should also be considered, such as creating incentives for employees which are tax-efficient. This can be crucial to retaining key members of staff and ensuring your startup looks attractive to potential employees when compared with larger companies already established in the space.

3. Exit

Being mindful of your exit (such as a sale of the company) strategy and reflecting that in the legal documents entered into can actually attract funders, as well as protecting your own position both financially and in terms of ownership.

4. Regulation

For example: any company raising money that is based in the UK or looking to attract UK investors will be required to follow the Financial Conduct Authority (FCA)’s rules. This will govern what you can say and to whom, and even applies to alternative sources such as crowdfunding. Navigating regulatory mazes such as this can be a daunting prospect, especially for a new startup.

Our specialist Corporate solicitors can guide you through the legal aspects of a seed fundraising process. Please contact us on 0161 832 3434.