Closing your first priced round is a major milestone.
Many first-time founders think they’re done once they get a term sheet, but that's far from the case. The equity financing process is often longer than most expect and can distract from what founders want to be doing: growing their business. While the time and money spent during the process might seem like a necessary evil for founders, there is a better way to prevent months of distractions post-term sheet.
Many argue that the startup fundraising process is broken, and this even includes the process post-term sheet. The length and price of closing a round of equity financing are major factors in this dysfunctional dynamic. So why do equity financings cost so much and take so long?
The average equity financing deal takes about six weeks to complete – and that doesn’t include the upfront work of actually finding and courting an investment partner. After agreeing on a framework, startups still have to conquer legal due diligence and documentation. This often gets expensive, with companies potentially spending $50k-$150k of their new capital on legal fees for document drafting and execution.
Too often, closing an equity financing round can grind business operations to a halt. Instead of focusing on new business, building your product, or recruiting the new hires you raised money to pay for, startup leaders are bogged down with legal diligence and investor relations. Startup growth is stunted before emerging companies even get to deploy their venture capital funds.
Let’s explore why equity financings are so arduous and expensive, and consider ways to avoid the standard startup pitfalls:
Reason 1: Startups & investors don’t outline key terms up front during the equity financing process
While all deals start with a term sheet, often not much time is spent in defining many of the key terms up front. On one hand, this makes sense for investors to do because it feels simple to companies and it lets the investor get in the round quickly; however, this creates issues down the road because lawyers need to spend time negotiating those key terms back and forth. This can lead to high legal fees that companies will need to pay.
Let’s imagine a scenario with two term sheets:
One is a light, one-page agreement that states the VC invests $5M at a $20M valuation.
The second is more robust and includes the same $5M at a $20M valuation, but it’s a 10-page agreement that outlines key terms like voting rights, board seats, etc.
The first, simpler term sheet is deceptively appealing because it’s easy for a founder to agree to. The longer agreement feels like the money comes with many contingencies that founders may have nothing to compare against, leading to them feeling like it might be a worse deal.
In actuality, the second term sheet is better because the light term sheet means lawyers will need to argue over these details — leading to higher legal fees on the company’s end.
The non-binding term sheet outlines the parts of the equity financing that the startup and investor truly care about, such as equity percentage, valuation, voting rights, etc. Defining key terms up front in the term sheet means you can more easily move into the equity financing documents – typically the standard set of National Venture Capital Association (NVCA) documents. In fact, with our automated equity financing, you can generate a full set of NVCA or Series Seed documents based on company structure and pro forma. These documents can span 100s of pages, take weeks to draft, and cost thousands in legal fees if there is a lot of back and forth needed.
Before you spend time and money on a novel’s worth of legal documents, make sure that you’re aligned with your investor on key items in the term sheet.
Related: A Guide to Term Sheet Terminology
Reason 2: Companies are paying high legal fees to execute standardized documents
No matter how unique your startup’s product or service, your equity financing documents are largely standardized.
Startup leadership teams are busy and dealing with legal documentation process can be intimidating — this is where standardization can help. Startup attorneys are certainly capable of drafting and executing hundreds of pages of docs, but their services aren’t cheap. They’re also overqualified – your attorney should be advising you on major strategy, rather than drafting fairly standard documents. In fact, many innovative, leading law firms are moving towards automation.
Startups can usually lower legal fee costs by leaning on automation where they can. With our automated financing, we draft hundreds of pages of documents that attorneys can review — saving companies significantly on legal fees and leaving attorneys more time to do high-value work. Learn how our automated equity financing can help here.
Reason 3: Too much manual tracking and not enough transparency
Investors and attorneys often go back and forth over different provisions and phrasings of the deal. There are also many signatures that need to be captured during the process. With so many documents, chasing down signatures and getting approval from each stakeholder can be a long, manual process.
Overall, there’s too much manual effort, not enough automation and very little visibility into the reasons for each party’s alterations to documents and terms.
There are better solutions in 2022. Helpful equity management software like ours can make this process smoother, faster and more transparent for everyone involved. Your digital tool should automatically generate standard documents, link document changes to the cap table and offer customized permissioning for document access. Startups should be able to manage and track the entire equity financing process on one platform – from generating documents to gathering signatures to actually closing the deal.
How to execute equity financing with more speed and fewer expenses
Equity financing doesn't have to be synonymous with business gridlock and high legal fees. Here are a few ways to close your round more efficiently:
Agree to terms up front.
Spend more time agreeing to terms up front in your term sheet to help speed up the process. Defining key terms up front in the term sheet means you can more easily move into the equity financing documents without a lot of back-and-forth legal hours.
Tackle day-to-day diligence.
Legal due diligence shouldn’t wait until you have a term sheet in-hand. Make legal and organizational maintenance a part of your monthly routine by standardizing your hiring process, setting internal deadlines and developing a document retention strategy.
Automate the equity financing process.
Fidelity's platform may be the only solution that fully automates the equity financing process, saving companies time and money and allowing them to focus on growing their business. We use an attorney-approved process to automate the standard parts of the deal in one single hub. Our platform can make equity financing less menial for attorneys, easier to manage for startups and more efficient for everyone involved. Learn more about automated equity financing.
 How To Fix The Broken Fundraising Process for Entrepreneurs (crunchbase.com)
Is equity financing taking you too long and costing too much? Fidelity can help you close in as little as 14 days. Get in touch with our team to learn more!
Third parties mentioned and Fidelity are not affiliated. Fidelity does not provide legal or tax advice. The information herein is general in nature and should not be considered legal or tax advice. Consult an attorney or tax professional regarding your specific situation.