Three ways to raise capital

Businesses are living organisms. To survive, they need inputs. Sustenance. Funds. Organic revenue is the most natural and convenient food for your business, but at some point, you might need to seek funding elsewhere. So, how do you raise capital and what are the rules you need to be aware of? What options are out there, and which is the savviest for start-ups? Read on for fundraising clarity and confidence.

1. Equity Financing

Equity financing is one of the most common ways to raise capital, through the sale of shares in your company (aka equity in your business).

While there are rules that apply to equity financing (set out under The Corporations Act 2001 (Cth) (the "Act")) for both privately-owned and public companies, we'll focus on privately-owned company requirements, because that's what most start-ups will be.

With the exception of crowdsourced funding (discussed below), a private company can't engage in any activity that would require disclosure to investors under Chapter 6D of the Act. The key exceptions are:

(a) "Small scale offerings". You can make a personal offer of shares to 20 or fewer investors, provided the Company raises less than $2 million within a 12-month period.

(b) "Sophisticated Investors". You can offer shares to a "Sophisticated Investor". This is someone who invests at least $500,000 or where a qualified accountant has certified that the investor has net assets of at least $2.5 million or a gross income of $250,000 for each of the last two financial years.

(c) "Professional Investors". You can offer to a "Professional Investor": someone who, for example, controls gross assets of at least $10 million; is a financial services licensee; is the trustee of a superannuation fund, an approved deposit fund, a pooled superannuation trust and a public sector superannuation scheme; or is a listed entity or a related body corporate of a listed entity.

(d) When the offer is to current shareholders of the company.

(e) When the offer is to people associated with the company. This includes employees; senior managers, their spouse, parent, child, brother or sister, or a body corporate controlled by any of these persons.

Note that if you do undertake a "small scale offering" be aware that you can't advertise or publish a statement that directly or indirectly refers to the offer.

2. Crowdfunding

Flow Hives and e-bikes are crowd-sourced royalty, demonstrating the power of pitching directly to your people. Platforms like Kickstarter, Indiegogo and VentureCrowd (not that we are endorsing any of these) provide a smart way to raise capital and test the waters of your market before going all-in on production. The main types of crowdfunding relevant to for-profit start-ups are:

  • Debt-based crowdfunding (discussed in more detail later)
  • Reward-based crowdfunding
  • Equity-based crowdfunding.

Reward-based crowdfunding is best for companies with a product or service to offer. Donors receive rewards based on the size of their donation, like free or discounted products and services, or a small gift.

Equity-based crowdfunding involves raising money from the public in return for equity in the business. Private companies can do so on the proviso that they have at least two directors; a principal place of business in Australia; a total consolidated gross asset value of less than $25 million; annual consolidated revenue of less than $25 million; a primary purpose that is anything other than investing in securities; and aren't listed. Companies can raise up to $5 million within a 12-month period. Retail investors can invest up to $10,000, while sophisticated investors can push this cap.

3. Debt financing

3.1. Bank loan

Bank loans can be tricky for start-ups because they usually require security and a good track record. Start-ups, by definition, have no track record! One thing worth noting is that a company can't incur a debt while insolvent, or a debt that causes it to become insolvent. Doing so can attract severe penalties for directors.

3.2. Convertible Notes

Convertible notes ("C-Notes") are generally a hybrid security; a mix of debt and equity. They start out looking like debt, with interest payments and a maturity date. Once a "triggering event" occurs, like an IPO or some other predetermined milestone, the total payable debt converts into equity at a set rate. C-Notes can be a quick and cheap way to raise funds in comparison to equity raising. In fact, we wrote a whole article comparing convertible notes with traditional equity that you can dig into here.

As with bank loans, companies are prohibited from issuing C-Notes while insolvent or if doing so would cause insolvency.

3.3. Peer-to-Peer Lending / Debt Crowdfunding

Debt-based crowdfunding aka peer-to-peer lending, is a way of collecting payments with a promise to pay them back later. Debt-based crowdfunding is great for businesses wanting quick capital, who'd prefer to pay back the money that they receive rather than give away equity in the company. It's another option for lower-cost financing with interest rates from 5-12% annual percentage rate ("APR") at the time of writing.

You can use a range of online P2P lending platforms to tap into funding from private lenders rather than banks or financial institutions. You'll need to provide detailed requirements of the loan you're seeking (loan amount, business objectives, purposes of the loan, etc) in a pitch, and submit your financials through the platform. Terms and conditions including investment limit, investor profile, or APR of loan repayment will be defined by the platform based on due diligence and background credit checks. Depending on the amount you're setting your sights on, you might need to provide security in the form of business assets or a personal guarantee.

If you're pursuing the debt crowdfunding route, it's vital to accurately state your intention: what the money will be used for. Otherwise, you run the risk of misleading and deceptive conduct under the Australian Consumer Law[6].

4. Final Thoughts

There's more than one way to get your start-up funding-fed. Choosing the right fundraising model starts with a thorough understanding of your business needs, and whether you're willing to bear the cost of obtaining finance. And we wouldn't be lawyers without drawing attention to the legalities of your chosen mode of finance. Know them. Abide by them. Raise capital like a pro.

The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.