In one of my earlier post I discussed the time challenges that start-up companies face when raising investment funds. Many start-ups greatly underestimate the time commitment involved and the slow timeline that is usually associated with raising funds. A related issue is that companies pursuing investment also frequently underestimate the costs that are involved in the process. This is a situation that illustrates the truth of the second part of the Johnston corollary to Murphy’s Law – “Everything takes longer and costs more.”
As part of helping clients work through funding, early in the process I ask clients about their budget or estimated costs for obtaining equity investment. Even though I’ve worked in the startup ecosystem for nearly twenty years, I’m still surprised by the number of times the answer is “we don’t have a budget” or “we don’t expect there to be any costs.”
What type of costs should the company anticipate and at what points in the process? There are multiple steps involved when pursuing investment, but let’s focus on the phases that typically involve outside costs:
| INVESTMENT STAGE | OUTSIDE COSTS |
| 1) Preparing for investment |
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| 2) Prepare proper investor materials, consisting of, at a minimum, a business plan including financial statements and pro formas, executive summary, a pitch deck, and private placement memo or other documents that will comply with securities law. |
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| 3) Negotiating deal terms via a term sheet. Besides valuation and investment amount, a proper term sheet will also deal with an array of other issues, such as investor shareholder rights, liquidation preferences, investor representation on the board of directors, investor information rights, tag-along and drag-along rights, no-shop provisions, and confidentiality. |
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| 4) Preparing and negotiating the definitive documents (stock purchase agreement, shareholders’ agreement, investor rights agreement, etc.) |
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| 5) Closing the deal |
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There may be other types of costs depending on the specific situation, but presumably the above information conveys the fact that significant out-of-pocket expenses are an unavoidable part of the process. The amounts vary depending on a variety of factors, including the experience level of the management team, the amount of investment pursued, whether pursuing angel or VC investment, and the length of time it takes the parties to agree on the investment terms. It is vital for company executives to meet with their lawyers and other service providers at the outset and have detailed conversations about estimating the length of the process and a likely range of fees.
