Guide: At what point does a startup transfer ownership to investors?
In the dynamic world of startups, two primary instruments of fundraising stand out: debt and equity. Let's delve into these financial tools and explore other methods that help startups grow.
When a startup successfully raises a seed round, it often issues common shares to its investors. This move solidifies the relationships between the startup and its investors, transforming them into full equity holders in the firm.
One such instrument, the Simplified Agreement for Future Equity (SAFE), was introduced by Y Combinator, a renowned startup accelerator, in 2013. Initially designed specifically for startups in Silicon Valley, SAFE is an agreement that anticipates a future opportunity for investment, with no maturity dates or interest rates attached.
Investors holding SAFEs can keep them for long periods without conversion. However, if a startup offers a SAFE to an investor, the investor will be able to purchase shares in the company during a future funding round.
Another instrument, the convertible note, is a debt instrument that can convert into equity at a point in the startup's life, such as a subsequent fundraise. Unlike SAFE, convertible notes do have terms, including interest rates and maturity dates, but these are usually adjustable.
Startups between the pre-seed and Series A stages often offer various instruments to investors in exchange for funding. At this juncture, a set valuation for the company might not be available, leading startups to issue convertible notes instead of common shares.
Loans with interest rates are a less common funding method for startups, particularly from banks. Instead, grants come into play, especially for non-profit organisations seeking to create impact. These grants are provided by wealthy individuals and organisations, given interest-free and without repayment obligations.
Personal funds and funds from family and friends are initial sources of funding for many startups. These early investments are expected to be positively transformed and returned as the startup grows and succeeds.
Holders of preferred shares, on the one hand, get first dibs on dividends, payouts in cases of potential bankruptcy or liquidation of assets. However, they do not have voting rights on the company's board of directors.
In conclusion, understanding the various instruments of fundraising is crucial for startups navigating the complex landscape of capital acquisition. Whether it's debt, equity, or grants, each tool serves a unique purpose in helping startups grow and achieve their goals.
