Business Lawyers Blog
Starting a new business is an exciting journey, but the most challenging aspect of any new endeavor is where to get the money to start. Often, this is the greatest question that entrepreneurs face in starting and growing their businesses and it’s a decision that can have significant consequences. Oregon startups have various funding options available, though selecting the right one requires research, planning, and often advice of counsel.
While there are many different iterations, the primary decision an entrepreneur has to make is whether they want to raise money through investment – that is to say selling equity in the business – or whether they prefer debt, or even a combination of the two. Below, we highlight some of the most common funding choices. We invite you to contact Structure Law Group with any questions about Oregon startups and business financing.
Raising Money by Selling Equity
The most traditional way to raise money for a business is by selling a piece of it. Ownership in a business, in the broadest sense of the term, is called “equity” and it is common for those seeking capital for their new or existing company. Like most things in business, the choice between selling equity in the company (as opposed to debt discussed below) involves considering relevant tradeoffs.
Most folks understand that those who have equity in a company will share in the profits, and losses. What this means is that if the Company requires more capital, it will be up to the equity owners, whether members (in an LLC) or shareholders (in a corporation), to recapitalize the company, that is to say, put more money in it. Conversely, if the Company makes money, the profits will belong to the equity owners.
However, there’s a more subtle tradeoff as well, which is the idea of control. Most entrepreneurs have heard of “silent partners,” which, legally, is a member or shareholder who has very limited control over the company. However, this is not the default model. In fact, in the absence of a contract limiting the rights of equity owners, the law will provide them significant decision making authority in most businesses by default. It’s also the case that when disagreements arise amongst business partners, it’s far more common for the dispute to be about control as opposed to profits and losses.
Therefore, before simply selling a piece of the business, it’s critical to consider two key questions. The first is, “Can you live with parting with a certain percentage of your profits in exchange for your investor’s capital?” However, the next question one must ask is, “Am I okay with this person exercising control over my Company?” This is a discussion that should be had with investors, and corporate counsel to ensure investors and those running the company are all on the same page.
Financing and Loans for Oregon Business Funding
Investments are attractive for start-ups because money can be brought in without incurring an additional expense. That is to say, if the company makes no money, the investors don’t get paid. However, some entrepreneurs don’t want to (or can’t) split their profits. Others simply don’t want to give up control. For those in this situation, many entrepreneurs look to borrow funds instead.
This model is familiar to most. Typically, the money is due regardless of business performance. For example, if the business had a great quarter, the same amount will typically be due on the loan as if the business performed terribly. As a converse to investment, lenders typically have very little or no say over how a business is run.
The other main distinction between investment and lending involves a concept called “liquidation preference” which is the legal term that described the order in which investors and lenders get paid in the even the company folds. Typically, in the case of insolvency, a business first pays off its loans and, if there is any money left, such is then divided amongst the owners. That is to say, if the business fails, the lender has a right to get paid ahead of the owners.
Mixing Debt and Equity
As with all things in business, the models start out basic, but can become highly complex as well. It’s quite common for businesses to have a mix of equity and debt. Similarly, there are certain financial instruments (such as Convertible Notes) that allow for investors and or lenders to change positions. Such an approach is common for companies that have been operating for some time, or that have specific needs.
Ideally, investment is matched with cash flow, so if there is an asset that will generate a certain amount of additional revenue every month, it might be best to consider a loan because the payment on the debt can be cleanly deducted from the extra profits that the asset adds without selling interest in the business. On the other hand, if a business is just starting out or considering moving into an area that is risky, then it might be best to consider selling equity because no one knows whether or not the new endeavor will be successful. Thus, it becomes better not to have to service debt (i.e., making loan payments) until the Company is certain that the new project or endeavor will be profitable.
We Are Here for You
The choice about how to raise money is fundamental to every startup. Structure Law Group provides legal services to businesses of all sizes in Oregon, California, and Texas. We are always eager to meet emerging entrepreneurs to discuss their legal needs. Call (503) 388-7500 or contact us online to schedule a consultation with our Oregon startup attorneys.