Nigerian Law Forum
While fund is greatly required at the startup inception stage, it is a major setback suffered by most startups as they have no proven track record of success and investors therefore consider them as high-risk investments. Notwithstanding, there are options of funding available to startups. The aim of this article is to explore the startups funding options as well as highlight some legal considerations.
Startup Companies aim at introducing new innovation in the marketplace which usually offers a new path from what has been obtainable by consumers. Although, one major requirement for startups to introduce and grow their idea is funds.
Having a new innovation in the marketplace that could be beneficial to the economy as well as generate income for the owner of the innovation is not enough if the amount of capital required to kick-start and grow the innovation is inaccessible.
A startup is a young company founded by one or more entrepreneurs to develop a unique product or service and bring it to the market1. These companies usually lack adequate capital to fund their innovation, they therefore, solicit for funds from different sources. These sources of funding are discussed below.
There are generally two types of funding that are available to startups. These are debt funding and equity funding.
Debt Funding2: This involves startups borrowing money from external sources to fund the operation of the business. The money borrowed is to be paid back at a future date with interest. A major form of debt funding is loan (bank loans or government loans).
Equity Funding: Startups rely on capital investment from investors. The capital invested into the business by the investors is exchanged for equity/shares in the company. What the investors get in return is not their money back but ownership in the company through the shares acquired. There are different equity funding options that are available to startups.
Before highlighting the various forms of equity funding, it is important to know that a major difference between debt funding and equity funding is that startups who use debt funding only have to repay the loan with the interest. They do not have to give up shares in the company to the lender like equity funding.
Angel investors: These are wealthy individuals, who could be friends are family. They invest capital in startups in return for equity in the company. Angel investors usually invest at the early stages of startups as they are focused on helping startups kick start the business by providing useful guidance.
Crowdfunding: This is the use of online platforms by startups to raise capital in small amount from a large number of people. There are three types of crowdfunding;
Venture capital: These are funds invested by professional investors into startups in exchange for equity in the startup company. This means that startups give up a portion of ownership in the company. Venture capitalists do not involve themselves in the early stage3 funding like angel investors because of the high nature of risk involved.
While these options are available, it is important to know the stages of funding before approaching investors. The stages of funding are;
Regardless of the option of funding chosen by startups, the process involved is usually contractual in nature. It usually involves lengthy and complex transactional documents which may not be fully understood by the startup. Professional/legal advise should be sought by startup to ensure that they understand the depth of these documents and that they are not signing their rights away legally
Some of these documents include:
There are different funding options available to startups, knowledge its current stage before approaching any kind of investor is essential and advantageous to the startup. Startups should also seek professional/legal counsel as they are more thorough with contractual documents.
1 https://www.forbes.com/advisor/investing/what-is-a-startup/
2 https://corporatefinanceinstitute.com/resources/knowledge/finance/debt-financing/
3 I. O. Nwanna, and U. O. Chiekezie, Venture Capital As A Source Of Fund For Entrepreneurs (2016), NG-Journal Of Social Development, Vol 5, No 3, June
4 https://clutch.co/consulting/resources/startup-funding-sources-new-businesses
Preye Ezonfade , LLB