The ways in which you get an investor interested in giving you money in exchange for ownership are endless, so I’m going to assume you have someone you’ve met who might be interested in investing in your company, so now what? If someone is interested in investing there are going to be two main questions they ask; how much do I need to invest and what do I get in exchange? If you are working with someone who is not “giving you a term sheet”, then you can take a soft approach or a more direct approach. Either way you have to negotiate what you believe the company is worth [see my blog on that topic] and that determines how much they get for whatever you are asking them to invest. So for example if you say “my company is worth $1 million pre-money [I’ll explain that in a minute], then if they give you $250,000 then after you have their money the company is worth $1,250,000 post-money and they own 20% of the company [$250,000/$1,250,000].
So pre-money and post-money are terms used to delineate what a company is worth before and after the money from an investment in put into the company. It makes sense right that if a company is worth $1million then as soon as you put $250,000 in the company’s bank account the company is now worth $1,250,000 right. Well that is pre & post money. Those terms will be used often, so now you know.
Whether you start out with a soft and squishy negotiation or whether you get straight to it, at the end of the day you need a term sheet. There are different types of equity investments but the type of legal entity you are largely determines what you call it. If you are an LLC then you are probably giving “units”. If you are a C corporation then you are giving stock and the type of stock varies but is generally called Common or Preferred stock. If you are an S corporation then you can only issue common stock.
Now I could do a dissertation on what the differences are between Common and Preferred, but the short answer is common has typical voting rights based on ownership % and preferred has a whole lot more rights. The types of rights vary but most typical are that they get their money back first before the common stockholders, they may get their money back and then share pro-rata with the common holders [that’s called participating, not pretty by the way], they may have rights to block certain decisions, or make the call on certain decision, they almost always have the right for their effective price per share to be reduced so that they have even more ownership if the next time you raise equity, the price is reduced below their price. And the list goes on BUT…
At the end of the day the simple process to raising equity investments is that you must negotiate the value of the company and what they are going to invest and what percentage of the company they as a result will own. You will likely need to put together a bunch of information for them to perform diligence on you. See my blog on diligence for what that looks like and you may want a business plan or a presentation on the company “investor deck”. You can offer them a Term Sheet for what you are willing to accept and that may get the ball rolling even more quickly. Best if your lawyer drafts the Term Sheet for you because they will understand your business structure. It shouldn’t take much time or cost and in the end you will be happy that you have all the bases covered. Once you have agreement with a potential investor they or you may draft the documents, and expect to pay all the legal fees for both sides. That is typical with any deal that the company who is getting the money pays all the fees. And once the docs are agreed upon you will go to “closing” similar to buying a house where you sign all the docs and are wired the money. Then the fun begins, having an investor interested in the company. So thanks for the question Tom; good luck and happy fund raising.