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Securing Series A funding is a significant milestone for any startup. Your business will have progressed through the seed stage and require additional funding to scale and reach new markets. However, this stage is about more than securing investment. It is also crucial to address vital legal requirements. Overlooking these legal requirements can result in legal disputes with investors and loss of control over your business. This article will explain the series A startup funding round and explore the specific legal considerations this round involves, sharing insights on how you can navigate this stage successfully.
1. Equity Stakes
By series A, you will likely seek investment from angel investors and venture capital firms. Founders typically offer investors equity in exchange for investment. Understanding equity stakes and dilution can help you maintain control over your company and make informed decisions about fundraising.
Equity stakes represent ownership in your business. When you offer equity to investors, you give them a share of your company. This share entitles them to a portion of profits and can provide them a voice in your company’s governance. The amount of equity you offer will depend on your business’s valuation and the amount of investment you require.
It is essential to consider the amount of equity you can offer investors. Equity dilution occurs when your company issues new shares, reducing the ownership percentage of existing stakeholders. Dilution is a standard part of raising capital.
However, it is vital to manage dilution carefully to retain ownership and control. To manage dilution, you can:
- ensure your valuation reflects your company’s market position and potential;
- reserve a portion of equity for potential investors and future employees;
- implement a vesting schedule among the founding team; and
- plan for future fundraising rounds.
2. Term Sheets and Shareholder Agreements
A term sheet outlines the basic terms and conditions of the investment. They are not legally binding but serve as a foundation for negotiations. Key terms in a term sheet include:
- valuation;
- the amount of investment; and
- investor rights.
After agreeing on the term sheet, an investment and shareholder agreement will formalise its terms. These agreements are legally binding and detail the rights and obligations of all parties involved.
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3. Corporate Structure and Governance
Before receiving series A funding, ensure your corporate structure is sound. Governance issues, such as problems with board composition and voting rights, also need addressing. Proper governance ensures smooth decision-making and protects the interests of all shareholders.
4. Due Diligence Preparation
Potential investors will perform thorough due diligence before committing funds. You should prepare for this process by organising all necessary documents, including financial records, contracts and other legal documents. Doing so will ease the investment process and enable you to build trust with investors.
Investors will scrutinise aspects such as:
- your business’s financial history;
- its governance structure; and
- its assets, including intellectual property (IP).
You should register and protect your IP portfolio, including patents and trade marks.
5. Employment Contracts and Equity Compensation
A successful series A stage will enable you to substantially scale and grow your startup. This scaling might involve hiring new talent and restructuring teams within your startup. In light of this, you should ensure you have robust employment contracts. Clear, well-drafted contracts will help prevent disputes and protect you and your employees.
Equity compensation, such as stock options, is also typical at this stage. Selecting and appropriately structuring a suitable plan can help you attract and retain top talent.
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Key Takeaways
As you approach series A funding, you should be aware of several critical legal considerations. Addressing these considerations ensures a smoother series A funding stage and can help secure investment for your startup’s growth. They include the following:
- understanding equity stakes and dilution and carefully considering how much equity to offer investors;
- thoroughly reviewing term sheets and investment and shareholder agreements;
- auditing your startup’s structure and governance to identify and fix any issues;
- preparing for investors to conduct their due diligence;
- auditing and protecting your intellectual property;
- drafting robust employment contracts; and
- selecting a suitable equity compensation scheme and structuring it properly if you plan to compensate employees this way.
If you would like legal advice about legal compliance or funding 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
In your startup’s early stages, series A funding is the first significant funding round in its efforts to scale its operations, focus on product development and reach new markets.
With the legal structure of an early-stage startup, the amount of equity startup founders give away in series A depends on various factors. These include your business’s valuation, the amount of capital you require and the terms you negotiate with investors.
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