Which type of Venture Funding is right for you?

If you have a startup business or an existing business that you would like to develop and grow, you could look into venture funding to provide you with the capital needed for expansion. In this blog post, we are going to discuss the the different types of funding available for businesses: Primarily Debt and Equity. We will also examine some of the new types of equity like SAFEs.

Debt

Debt is not your typical form of Venture Capitalist (VC) funding, and is the type of funding that you will obtain from a bank. It involves a loan, which you can then use to develop your business. You are then indebted to repay the loan with interest. Most venture capitalists do not provide debt financing because the interest rates are too low (low upside for the VC) and most startups do not have collateral to secure the loan (high downside for the VC).

Equity

This is the typical type of investment a Venture Capitalist will make in your business and, simplistically, it is X amount of currency for X percentage of your business. If the business is a startup and has developed a minimal viable product (MVP) and has some form of market validation, then this type of investment is called seed investing/funding. If the business is just a concept, and a small investment amount is required then angel investors provide the funding.

Convertible note

Often, it is difficult for the entrepreneur and venture capitalist to agree on the exact valuation of the startup. As a result, in seed investing it is common for a convertible note to be used. A convertible note allows investors to delay establishing a valuation for the startup business until a later round of funding or a milestone is reached.

Convertible notes are structured as loans with the intention of converting to equity at the stated milestone. In order to compensate the angel or seed stage investor for the additional risk of investing in the earlier round, convertible notes often have additional clauses such as valuation caps or discounts. Valuation caps serve as the maximum valuation for which the convertible note will be converted into equity. Discounts reward the early investor for taking a larger risk than the later investor. These are discounts on the later round valuation.

For example, company X raised R500 00 using a convertible note with a valuation cap of R10 million and a discount of 20% from Investor NP. After 12 months, company X raised R5 million. Thus, Investor NP will receive R500 000/R4 million or 12.5% of the company.

SAFE

Another form of equity is a Simple Agreement For Future Equity (SAFE) and it is a new alternative to convertible notes. A SAFE is intended to be simple for both companies and investors and only requires the negotiation of one item, the valuation cap. Unlike the sale of equity in traditional priced rounds of financing, a company can issue a SAFE quickly and efficiently. In the SAFE, a flexible one-document security, the investor and company agree on the valuation cap and mutually date and sign the SAFE.

The investor then sends the company the investment amount. Nothing then takes place until the occurrence of one of the specific events described in the SAFE. A SAFE has no maturity date and is only designed to expire and terminate when a SAFE holder has received stock or cash in an equity financing, change of control transaction, IPO or dissolution — whichever occurs first.

If you have a business and are interested in standard equity financing or a SAFE, please visit SeriesSeed.co.za. This is a website, put together by Newtown Partners with help from their partners, that includes documentation for standard equity financing (such as a subscription agreement) and a SAFE document.