How to navigate the startup investment journey

Published on
April 8, 2024

The statistics are pretty damning - in the US, only about 2 out of every 10 new businesses survive the first year. That’s a success rate of just over 20% - not great news for business owners.

Now imagine that you're on the brink of making one of the most significant decisions in your startup's journey—exchanging a considerable share of your company for the funding that promises to catapult your growth to new heights. This moment is fraught with anticipation, excitement and, yes, a fair share of anxiety.

If you want to make it into the second year and beat the odds, you’ll need outside investors.

We’ve put together a short guide to the investment process that walks you through everything from advance planning to funding and negotiations.

Beforehand: finding the right investors

It’s never too early to consider what your ideal investors look like. You’re probably familiar with the marketing concept of the ideal customer; determining who needs your services or products and why. Applying the same concept to your ideal investor can lay the groundwork for productive relationships and long-lasting investments.

Networking strategies

Your journey starts with finding the right investors, those who not only bring capital but also align with your vision and understand your business. Networking is key. Attend industry conferences, leverage online platforms like LinkedIn and don't underestimate the power of a warm introduction from a mutual contact.

Researching investors

Before diving into discussions, research potential investors. Look into their investment philosophy, previous startups they've backed, and their involvement level post-investment. This ensures you're approaching those whose expectations and support mechanisms match your needs.

Step 1: the importance of due diligence

One of the most critical and intimidating steps of the investment process is due diligence. In this stage, investors will get to know your company intimately so that both parties can determine if the investment is a good fit.

Fortunately, a bit of preparation, along with being proactive, can position you for success.

Understanding due diligence

Due diligence is a two-way street. While investors scrutinize your business model, financials, and market potential, you should also assess their fit with your startup. This mutual evaluation lays the groundwork for a successful partnership.

Preparing for investor scrutiny

Having all essential documents legal and business documents ready for the due diligence will significantly speed up the funding process. Investors will generally look at these areas:

  • cap table composition (ownership ratios, ESOP pool size)
  • group structure setup (key assets and financing consolidation)
  • Intellectual and property rights (contracts with key people, trademarks, NDAs)

Demonstrating a deep understanding of your startup's position and potential will make you a more attractive investment prospect; it also reduces the burden and potential headache of the due diligence process.

Step 2: establishing the term sheet

At this stage, both parties will establish the key terms and conditions of their cooperation. This is an ongoing process, with revisions and changes proposed as part of negotiations.

Term sheet explained

The term sheet is a crucial document outlining the proposed terms of investment. It covers valuation, equity, voting rights, and more. Understanding each element is vital to ensure it reflects a fair and beneficial agreement for both parties.

Negotiating the term sheet

Don't shy away from negotiating terms. Focus on critical aspects like valuation, equity offered, and clauses that could affect future fundraising efforts. Remember, negotiation is part of establishing a partnership that respects both parties' interests.

Step 3: exploring funding sources

Most startup funding, at least in the EU, will come in one of two forms: convertible loans or equity financing. Both are commonly used, with advantages and disadvantages to each.

Convertible loans

Convertible notes and SAFEs are popular for their simplicity and flexibility. They offer startups a flexible financing option, providing immediate funds with the potential to transform into equity or be repaid at a later stage.

This arrangement allows startups to secure necessary capital without immediate ownership dilution, making it an excellent choice for early-stage ventures or those uncertain about their current valuation.

Equity financing

Offering a direct equity stake in exchange for funding, this option is transparent but requires setting a valuation upfront. Equity financing involves investors receiving shares in the company, along with all associated shareholder rights.

This type of investment is well-suited for startups looking to raise larger amounts of capital. It also appeals to those with access to a broader investor base, and ones prepared to allocate time and resources towards establishing new governance structures.

Step 4: reaching a standard agreement

A standard agreement serves as the legal framework for negotiations. Once completed, it will contain all the details of what investment is being received, under what conditions and what the investors receive in return.

Put a different way, the investment agreement is one of the most critical documents your startup will ever create. To make the process easier, rely on proven templates and engage legal services to make sure that both you and your investors are fully protected. Templates are region-specific; here are good ones for the US and Czechia.

Step 5: navigating negotiations

What areas will you need to negotiate with your investors?  the most common areas of negotiation include:

The size of the share acquired establishes how much stake an investor has in the company. The larger the investment, the larger the share, at least as a general practice.

Company valuation determines exactly how much the investors get for their investment. Valuation can and will change, but the initial valuations set the course.

Investor rights range from the right of first refusal (ROFR) to common and preferred shares or drag-along and tag-along rights for minority shareholders. Each of these and others will need to be negotiated and clarified in the term sheet as part of the negotiations.

Strengthening your starting position

Embarking on the investment journey is a pivotal step in your startup's growth. But you don't have to do it alone. Our team of legal experts specializes in guiding startups through the investment process, ensuring your journey not only accelerates your success but does so with your vision and values intact.

You can find some additional resources here:

Want your legal support for your next investment round? Reach out to us here!

  1. Beforehand: finding the right investors
  2. Step 1: the important of due diligence
  3. Step 2: establishing the term sheet
  4. Step 3: exploring funding sources
  5. Step 4: reaching a standard agreement
  6. Step 5: navigating negotiations
  7. Strengthening your starting position

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