When seeking equity funding—whether through venture capital, angel investors or even family and friends—proper documentation is essential, proper documentation is essential. Proper documentation helps ensure that the understandings of all parties are properly noted.
There are several documents, both legal and financial, used throughout the equity-financing process, so best practice is to seek advice from a qualified attorney before you begin looking for equity investors.
Each funding scenario is unique, but the items below are meant to help you get started on terminology and concepts you may encounter throughout the financing process.
A business plan is a strategic document that communicates business goals and how they will be achieved. It’s often used to apply for funding and to establish three- to five-year goals for a business.
Business Pitch Deck
Considered a modern version of the traditional business plan, a pitch deck is a concise presentation that briefly describes your business to potential investors. The goal of the pitch is to clearly communicate your company’s value proposition and the plan to overcome any hurdles the company is working to resolve.
Often portrayed as a company’s financial condition, a balance sheet is a basic financial statement that measures a company’s assets, liabilities and ownership equity.
A company’s assets, such as physical property and intellectual property, give investors an idea of how much a company owns. On the other hand, liabilities, such as payroll and debt, specify how much a company owes. Lastly, ownership equity indicates the amount invested by shareholders and the company’s retained earnings.
A capitalization table is a record of all the shareholders of a company, along with their respective ownership percentages. It also outlines all of the securities issued by a company to investors throughout different investment stages (i.e. series or common/preferred shares and options/incentives), as well as the various prices paid for those securities.
This table also specifies ownership shares on a fully diluted basis—if all convertible notes and stock options are exercised—therefore enabling a company’s ownership structure to be easily ascertained.
Convertible Promissory Note
Convertible notes start out as debt but could get converted into equity upon the occurrence of a specific event. The parties specify when and how the debt will get converted into equity. Typically, debt gets automatically converted into equity either on a future date or upon qualified financing.
Corporate Director Agreement
If you bring on an angel investor, it’s possible that a seat on your company’s board of directors is included as part of the agreement. A corporate director agreement is typically drawn up between a corporation and a duly-elected director that specifies the director’s duties, corporate meeting requirements, and compensation, if any. These agreements also usually contain a non-disclosure clause and a section meant to ensure the director doesn’t have conflicting obligations.
If your company is a corporation, you are required to hold annual shareholders meetings and periodic directors meetings. If you are pursuing equity financing, meetings with the board of directors and with shareholder are needed in order to approve investors, issue new stock and, if applicable, appoint new directors. In addition to holding meetings, you must also keep accurate minutes, which is a written record of these meetings.
Discounted Cash Flow Projection
A popular valuation method, a discounted cash flow projection (DCF) can be used to establish a monetary value for your business during different stages of the equity-financing process. DCF estimates how investment funds will affect your future cash flows while discounting the time value of money.
Share Subscription Agreement
This agreement is between a company and an investor, whereby the company promises to sell a specific number of shares to the investor at a certain price.
Typically, this agreement is written and used to memorialize the financing terms that a company and investor have fully agreed upon.
A term sheet is an important document that a company seeking financing provides to potential investors.
A term sheet is usually non-binding and specifies the amount of financing sought, price per share, voting rights, redemption rights, closing details, and more. Additionally, this document specifies the total number of directors (if any) that investors will be entitled to elect to the company’s board.
Also called a profit and loss statement, an income statement measures a company’s profits from all sources while deducting its losses during the same period of time.
Cash Flow Statement
A cash flow statement measures the amount of cash a company generates and spends during a specific period of time. A cash flow statement can help investors determine how much revenue a company is generating, where it’s coming from, and how it’s being spent.
These documents–among others–will help protect your interests as well as the interests of, other co-founders and investors.