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Starting a business often requires an influx of capital early on to turn your business idea into reality. As a startup founder, seed funding represents your new business venture’s first significant external investment round. The capital you secure during seed funding can be crucial for funding your market research, initial market entry, and product development. However, raising this funding comes with legal complexities that you should understand and plan for to protect your business interests and those of your investors. This article will explain seed funding for startups and highlight several legal considerations associated with seed-stage finances.
Funding Available at the Seed Stage
At the seed funding stage, you will be looking to secure enough capital to take your business from a concept to a functioning operation. Several funding options are available. The following table outlines some of these options.
| Type of Funding | Explanation |
| Angel investors | Angel investors are high-net-worth individuals who provide capital to businesses with high growth potential in exchange for equity or convertible debt. |
| Venture capital firms | Venture capitalists are investors who pool their funds and invest as a partnership. They tend to provide larger amounts of funding in exchange for equity. |
| Crowdfunding | Crowdfunding platforms allow many individuals, each of whom invests small amounts, to pool funds for new businesses and concepts in exchange for equity, rewards, or pre-orders. |
| Friends and family | You might receive informal loans or investments from your personal connections. |
| Seed Investment Enterprise Scheme (SEIS) | The SEIS is not a form of funding but allows your investors to benefit from tax relief. If your company is eligible for the scheme, it can be easier to attract investors. |
This guide aims to introduce founders to the UK startup market. It provides extensive insights and practical advice on essential steps for launching your startup in the UK.
Key Legal Considerations for Seed Funding
Securing seed funding can be transformative for your new business, but it also requires a lot of preparation. The following sections outline the key legal considerations you must address during the seed funding stage.
1. Equity Distribution and Ownership Rights
One of the most important legal aspects of seed funding is negotiating equity distribution. Investors might require a share of your company in exchange for their capital, meaning you must be clear about how much equity you are willing to give up. Equity distribution can affect ownership control and decision-making within your company.
You should consider the consequences of equity dilution. Equity dilution occurs when your company issues new shares to investors, diluting the ownership of existing stakeholders. You will want to retain enough equity to maintain control over your startup’s direction. It is also crucial to remember that there are many more funding rounds to follow. You will want to retain enough ownership and also have the capacity to give further portions of equity to potential future investors.
2. Due Diligence
Investors typically conduct due diligence to assess the viability of the business before committing funds. This process thoroughly reviews your startup’s legal, financial, and operational aspects. You should ensure that your legal documentation is in order, including:
- contracts;
- intellectual property ownership; and
- financial records.
3. Terms of Investment
You will need to agree on the specific terms of investment. A term sheet usually outlines these. This document is a non-binding agreement that highlights key points of the deal. The term sheet will eventually form the basis of more detailed legal documents like the investment and shareholders’ agreements.
Key elements of the term sheet include the following:
- the agreed-upon valuation of the company;
- the investment amount;
- what will happen to the investor’s investment if you sell or liquidate the company; and
- anti-dilution protections.
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Key Takeaways
Seed funding is a crucial stage for any startup. It offers the opportunity to turn your business concept into an operational startup. However, your choices at this stage can have significant legal implications. You should be mindful of the impact of equity dilution and investor rights and ensure your business is legally compliant before seeking investment. By engaging experienced professionals, such as startup lawyers and accountants, you can work to secure seed funding and lay the groundwork for long-term sustainable success.
If you would like legal advice about seed funding for your startup, our experienced startup lawyers can assist as part of our LegalVision membership. For a low monthly fee, you will have unlimited access to lawyers to answer your questions and draft and review your documents. Call us today on 0808 196 8584 or visit our membership page.
Frequently Asked Questions
Seed funding typically comes from sources such as angel investors, venture capitalists, crowdfunding platforms, or friends and family.
Legal documents such as term sheets, shareholders’ agreements, and investment agreements are often crucial during the seed funding stage.
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