How to raise money by selling stock
posted by Netcapital, November 16, 2017
You’ve decided to start a company. Woo! You hit upon an idea in the shower and figure it’ll be 5 years tops until you’re the next Zuckerberg. A few months go by, things are going well, your product looks good, but you need more cash, you need to hire, you need to grow. You can’t max out another credit card, so you’re looking for external capital, but where do you start? What probably comes to your mind is going off to a bank to secure a loan or setting up meetings with venture capitalists to get a term sheet. What you might not have considered is selling common equity by issuing stock. Of course, each method comes with its advantages and disadvantages, so we thought it might be helpful to discuss the most founder-friendly method to raising capital: issuing stock (or membership units if you’re an LLC).
Why common stock?
There are two main reasons why a company would want to issue common stock: cash flow and alignment.
Cash flow - When issuing common stock or membership units, a company raises capital that does not have a fixed timeline to be repaid the way a loan does. This frees up cash flows for other expenses and keeps debt off the balance sheet.
As a founder, you want to do what’s best for your business. While a bank loan offers you capital without diluting your ownership, debt can be a burden on young companies. A loan requires a specific timeframe to pay back but the company might not have the necessary cash flows to repay the debt which could negatively impact its balance sheet. Not to mention interest, which can accrue into a costly amount.
Alignment - When investors possess common stock or common membership units, they are putting themselves in the same boat as the founder, sink or swim, with the same security ownership. To put it simply: the investor generates her or his largest return if the founder also makes the most money.
This investor-founder dynamic is different for every other method of raising capital. Many founders confuse convertible debt as a solution to this dynamic for loans. Through convertible debt, the company receives a loan which has potential to turn into equity at some future event, called a qualified financing. However, convertible debt is still debt, just like the bank loan. At the maturity date, if there has not yet been a qualified financing, investors have a legal right to ask for their principal and interest from the company repaid in cash, as any creditor would upon maturity of a debt. The investor is motivated to get the best conversion price, or get paid back on maturity of their debt. Neither of which aligns the investor perfectly with the founder.
With venture financing, your company is inviting an entirely new perspective and set of goals onto your board. Often, venture term sheets will have certain preferences and other protective provisions such as liquidation preferences, participation rights, rights of first refusal, tag along rights, and drag along rights. These sorts of preferences, held only by your investors and not by you or your team, can create a divergence in goals and objectives for the company.
How to issue common stock or membership units
There are a series of steps companies need to follow in order to issue common:
- Determine a fair valuation for your company - here are three common methods: Berkus, Venture Capital, and Scorecard.
- Calculate your share price by dividing your company valuation by the total number of shares outstanding.
- Select the maximum number of shares you are willing to sell at that share price.
- Make sure your company has enough shares authorized for you to issue that number of shares. If not, amend your Operating Agreement or Corporate Bylaws to authorize the necessary number of shares to be issued.
- Draft a stock subscription agreement that details the terms of the offering. It is wise to look for legal counsel to review the agreement. You may also consider working with a platform. For example, Netcapital helps with all legal documentation and regulatory filings when a company lists an offering on its platform with no upfront charge.
- Sell sell sell! Talk to your business connections, your friends, your family, your customers. Discuss your company opportunity and why they may consider investing in your deal. Using a platform like Netcapital can ease the burden of distributing the offer and managing all of those conversations in one place.
Depending on your network, you may want to take advantage of new security exemptions that allow anybody to invest in your company, not just the rich and wealthiest 3% of Americans. To learn more about raising capital, or how to properly engage your social business graph to accomplish your fundraising goals, feel free to reach out to us at firstname.lastname@example.org.
5 Criteria to Look at Before Making an Investment Decision:
posted by Netcapital, June 19, 2017
We sat down with Alan Matthews, advisor to Netcapital, angel investor, and Founder of security company Rapid7 to discuss what he considers when evaluating an investment opportunity.
Question: Alan, you must see a lot of deals come across your desk. What factors do you look at before making an investment decision?
Alan: I look at 5 key dimensions of the business: TAM, Technology, Team, Fit, and Exit Strategy.
Question: What is TAM and why is that the first thing that comes to mind?
Alan: TAM refers to the Total Addressable Market. I look at the TAM and the acceleration of the addressable space. What is the market this business is in? Is it a new market? Is it accelerating? Is it an existing market that there is something new to do in? Without a market, you can’t build a company with any real value.
Question: Are there particular characteristics of the market you look for that make it more or less interesting to you?
Alan: Generally speaking, if you have a market that is less than $1B it is very difficult to build and scale a company for exit. It has to be at least $1B, preferably $2B or more and needs to be something that people are focused on or will focus on. It’s very difficult to have a company selling something that’s not in any defined market because no one will follow you. You don’t get any analysts, or anyone knowing what it is, and you’re constantly having to explain yourself. Of course, if you have a new idea which will take time to adopt then it’s a longer road to success, not always a bad thing but not ideal.
Question: What about the technology do you consider?
Alan: With technology it’s one of two things, legacy technology or new technology. I like either. You can buy a legacy company and milk it for the long tail, or invest in it and grow it into a new market. The problem with legacy businesses is they’ve been created, and it’s difficult to do something new. If it’s new, I need to understand if it’s modern and will it last? Do I like the platform it’s driven by? Do I like the way it’s being engineered? Is the engineering team strong or will it have to be re-written again and again, which requires continued investment. How much will that cost and how does that fit into the TAM? Whether it’s legacy or new technology I need to have a clear understanding of the company’s technology and where they’re going with it.
Question: What do you look for in the entrepreneurs you’re investing in?
It is very important to understand the team. Who are these people? Have they worked together before? If you take them into separate rooms and ask them individually what they’re doing will they say the same thing? Do they like each other? Do they work well together? Are they polite and kind to each other? Are they good leaders? Do they know how to manage? Overall, the team has to be strong in their ability to create more than just themselves and dynamically understand what they’re doing and enjoy doing it. It really has to be everyone with linked arms looking outwards. As a company accelerates it places pressure on the team to do more with less and only some, probably small number of them, will get it and move to the next phase of expansion.
Question: How do you identify if someone is a good leader?
Alan: There are only two questions I ask to identify a good leader:
- How do you manage? Any answer is fine as long as it’s not “instinctively”. You need to have a model and you need to have objectives and measure results toward those objectives in concert with the managed employee.
- Who have you created? Give me his or her name and number. I’m going to talk to them. When I do, will they agree with the statement that you created them? How did you get him/her to where he/she wanted to be?
Question: What exactly do you mean by fit, and how does that help you determine if a deal is right for you?
Alan: I like to invest in things that I know, so fit is very important to me. Do I know what these guys are doing or does it just sound good? Can I use my knowledge and what I’ve done to help them? If I don’t know the space I have less capability to evaluate if it’s a good investment. For me, inside sales models and technical innovation are my areas of expertise and tend to be where I focus my investments.
Question: What kind of exit strategy do you typically look for?
You’re either going to IPO and be an industry giant, or you’re going to be bought. 99% of the time you’re going to be bought. So the question is, do you know who is going to be buy you and what you need to look like? Are you going to be the pretty girl at the party? If so, you’ll need the right dress. It’s quite valid to build your company to be acquired by someone specific. Are you talking to the people that might acquire you? Are you using the technology of a particular acquirer? What’s your strategy? A lot of people don’t have a strategy, they just want to grow the company, but you need to have a plan.
As a closing thought on picking investments Alan stated “good judgement comes from experience, which comes from bad judgement”. Picking the right deal is hard, and often takes experience, but establishing a consistent due diligence process is a first step in the right direction.
Jason Frishman speaks on The Innovation Engine
posted by Netcapital, May 22, 2017
This special episode of The Innovation Engine features a number of interviews from the floor of last week’s TechCrunch Disrupt conference in New York City. Disrupt is a bi-annual event that features panel discussions with some of the leading minds in the technology space and serves as a launching pad for the next great batch of tech companies looking to change the world.
Join Jason Frishman, Founder & CEO of Netcapital and Will Sherlin from The Innovation Engine, as they discuss Netcapital’s role as the official private securities platform for TechCrunch Disrupt, and the difference between Netcapital and crowdfunding platforms like Kickstarter.