‘Necessity is the mother of invention.’
It might be an old adage, but it still rings true. Take for example one of Canada’s most affluent provinces: Alberta. Prior to the pandemic, its economy was driven by the resource sector.
But when COVID-19 hit, the bottom fell out of the resource market, massively disrupting the province’s financial system.
In response to the bottoming out, the Alberta government made economic diversification a top priority for its COVID-19 recovery plan. And while the tech sector was certainly growing in Alberta prior to the pandemic, the investment into new technology and innovation has been tremendous.
Accelerate Fund supports the growth of early-stage Alberta technology companies with a venture capital fund that matches angel investment.
While all this external funding might be extremely attractive to entrepreneurs, there are several critical considerations start-up CEOs, both in Alberta and across the country, need to be aware of before taking on outside capital. We spoke with Caravel Lawyer John Tyrell and compiled the list of top questions to ask yourself before taking on external funding, as well as advice on how to protect your business throughout the investment process.
1) ‘Is my business ready to take on funding?’
This may sound obvious – but if your business doesn’t have defined goals, a competent team and experienced management, you may not be ready to take on outside investment. It’s not enough to have a great idea or a great product, you need a clear vision and plan, and a qualified team – both internally and externally – that can help move the business forward. This means bringing on experienced accountants, engineers, sales and marketing professionals, legal counsel, and HR experts.
As a tech start-up, having someone on your team with a background in government funding initiatives and an understanding of the Scientific Research and Experimental Development (SR&ED) tax incentive program could be hugely beneficial, providing your business access to funding without having to issue equity.
You’ll also want to ensure you have strong connections in the local business community, especially with professionals who sit on advisory boards. Without these requirements, it will be extremely difficult to generate a decent ROI on outside investments.
2) ‘Why do I want this funding?’
Sure, getting money is great when you’re a start up – but do you know what you’re actually going to do with it? What are your short-, medium- and long-term goals? Is this funding just to prop up the business so it can get to the next stage of funding? What are you prepared to give up for this initial round of investment? Are there other ways you can raise capital without asking for outside investment (perhaps applying for non- repayable government grants)? Consider how much equity and control you are giving up in the business in exchange for this funding and make sure it makes sense for the future of the business.
3) ‘Do I understand all my business’s legal requirements?’
There’s an old proverb about lawyers (and mechanics): You can pay them now, or you can pay them later. But if you pay them later, it’s going to cost you a lot more. That’s why it’s so crucial for start-ups to assess their legal challenges early on in the idea phase. Ideally, you’ll have a lawyer who works closely with your business from day one. This way you can be proactive about solving legal issues (and avoid hefty legal fees later).
In many cases, entrepreneurs ‘don’t know what they don’t know’, so experienced legal counsel can help highlight key legal considerations they might not be aware of. They can also help with strategic legal work, including ensuring your corporation is set up properly and drafting legal documents such as NDAs and employment contracts. Down the line, they can also help with protecting your IP assets, including patent, trademark, copyright, and industrial design protection. This protection will be critical when it comes to drafting up agreements with prospective investors.
4) ‘Do I have the right team of lawyers?’
In the same way you wouldn’t hire just anyone for your internal team, you don’t want to hire just any legal counsel either. You want a legal team that is a good fit for the business and can become a trusted advisor. Take note of how they conduct themselves, their response time, how they deliver their services, their billing practices (e.g., do they charge you $200 for every little phone call? Most start-ups can’t afford those kinds of fees). Have a discussion and agree on the mutual expectations of the relationship up front. A common mistake is to assume that one lawyer is all you need, and they can solve every legal problem. In reality, you’ll likely need specialized lawyers to help with specific legal issues. A good lawyer will happily recommend a lawyer within their own firm or other firms from their network to help support your specialized needs
5) ‘Are my rights going to be protected?’
The best way to ensure you have adequate protection before you receive outside funding is to have trusted
legal counsel to support you. They can tell you how a “normal” investor/investee agreement is structured and ensure the term sheet is a win-win for both sides. It’s important to understand the obligations you are undertaking and what rights you are giving away when you accept funding. Look through any investor rights agreements or shareholders agreements carefully so you’re making a fully informed decision. And make a good first impression with prospective investors. Before you get to the table, sit down with your legal counsel and understand your goals and have your corporate records and minute books set up and complete. Being organized makes you look professional and competent to investors, but it also arms you with useful information so you can safeguard yourself during these meetings.
6) ‘Am I prepared to make changes to the business?’
Change in this case means taking advice from trusted advisors about strategic business decisions. Are you prepared to take constructive feedback from your senior team, your investors (who likely have years, if not decades, of experience launching successful businesses) or your legal counsel? It’s easy for entrepreneurs with a solitary view of their organization not to notice outside threats or obstacles, and potentially run their business into the ground. While you still want to retain control of your company, being open minded and ‘cutting the umbilical cord’ is essential if you want your business to be successful before, during and after taking on external funding.
7) ‘Is this investor a good fit for the business?’
Remember that you can’t be everything to everyone. If an investor offers you money to do something against the ethos of your business, and you take it, you risk compromising on your plan and vision and losing focus. Make sure your investment partner is a good fit for the organization in both competency and values. Do your due diligence on any prospective investor to see how they’ve historically managed their investments; how active they’ve been in the partnership and what they’ve expected from the investee. Talk to other companies they have invested in to see how they interact with their investee companies. Find out if they are patient or if they want their returns quickly. Determine what their reputation in the community is like.
8) ‘Are the terms of the investment agreement clear and fair?’
A wise piece of contract negotiation advice goes as follows: “The deal should lead the paper; the paper shouldn’t lead the deal”. This means in order to be efficient and effective you should have the terms and conditions of
an investment agreement defined and agreed before you put it on paper. Drafting a legal agreement on the fly and seeing how it goes can be an expensive, frustrating, and time consuming process. Clearly establishing the terms of the agreement with your investor (and internal and external teams) beforehand will facilitate a more productive process, leading to a better investment agreement between all parties.
9) ‘Am I taking full advantage of my partner relationships?’
Having a good investor relationship isn’t all about the money – there are lots of soft, ‘off balance sheet’ benefits that the right investor can provide. Finding an investor with experience in your industry can often
help accelerate your growth. They can look at your business plan and spot gaps. They can provide insights into the marketplace, trends, alternative applications for your product or service and networking and partnership opportunities. They might also know other co-investors who are interested in funding your business.
A good investor will have a strong network of contacts to put your idea into context, understand where you might be relevant and who can provide other non-financial help and advice you may need. They have been there before so they can mentor you and help with your current challenges, as well as prepare you for challenges you will face down the road.
Thinking about taking on outside capital, but need some experienced legal guidance? Caravel Law brings top quality legal services to start-ups, and businesses of all sizes. Get in touch with us today to find out more.
The information provided in this article is not intended to be legal advice. Many factors unknown to us may affect the applicability of this content to your particular circumstances.