Start-Up Entrepreneurs Can’t Overlook Disclosure Fundamentals

For some business founders, the path from an unfunded vision to a capitalized business enterprise seems effortless. Other entrepreneurs remain daunted by the task of acquiring investment capital and are stymied for months or years. What makes the difference?

Entrepreneurial vision is the lifeblood of both the US and global economy, but overlooked business and securities disclosure fundamentals often impede the path to raising capital.

First-time entrepreneurs should follow certain fundamental business and legal principles to transform an idea into a successful operating enterprise.

Founders paying heed to these key factors are likelier to succeed, whether the economy for new capital is vigorous or stagnant. They also put themselves in a strong position to access investment capital from angel investors, venture capitalists, strategic partners, accredited investors, or mixed-investment communities.

With entrepreneurship on the rise in the US, now is the time to revisit business and disclosure fundamentals that are often overlooked. If you’re a business founder raising capital for the first time, consider the following steps.

Create a comprehensive business plan. A surprising number of founders seek outside validation of their business before preparing an in-depth business analysis in writing. Although it’s customary for an investment deck to be distributed to prospective investors, there is no substitute for preparation of the underlying business plan that addresses the investment case for the product and validates the data used in the pitch deck.

Define the target investor. Entrepreneurs should have a general idea of the target investor—whether an angel investor, private equity, venture capital, accredited investors, mixed community investors, or a combination.

If the target investor is a venture capital fund, it will expect to see a capitalization table with the price of new shares or the percentage of the venture funds available to investors, as well as projected revenue and revenue growth. The offering may fail if the investor community doesn’t see a path to profitability or an eventual path to exit through an initial public offering, sale of the investors’ position, or sale of the company.

The venture capital investor will generally need to exit the investment within three to seven years with appreciation on its investment. If the investor doesn’t see a clearly delineated return on their investment, they’re unlikely to invest funds.

Sell the company’s consumer value proposition. It’s important to distinguish the company’s unique value proposition, differentiating it from the competition if there are earlier entrants with a similar product or service.

For the investment opportunity to gain any interest from investors, focus on speaking to the potential customers, understanding what the consumer needs, and identifying any “pain points” the product or service solves. If the business creates a new product or service with no existing customers, that strategy must be clearly explained to investors.

Avoid underestimating the startup’s capital needs. Founders often underestimate their early funding needs to conserve early-stage equity. However, smaller tranches of capital will be more difficult to acquire in some instances.

Moreover, underestimation of capital needs could prolong the timeline expressed for meeting revenue and growth milestones. If modest funds are needed, in lieu of an equity sale, consider a promissory note or convertible instrument such as a simple agreement for future equity or promissory note convertible to equity.

Hire a chief financial officer or finance staff. The finance team will develop projections and a valuation model, which is critical to a company’s success. If the valuation pitch isn’t based on sound financial or accounting models, investors will likely not trust the valuation model and will pass on the opportunity. Investors typically want to see someone with experience as a comptroller or CEO in the industry or sector.

Determine investor interest. Following the JOBS Act of 2012, US federal securities laws have been modified to encourage investments in early-stage ventures. In certain limited cases and assuming applicable state law allows, companies are permitted to make safe-harbor protected statements on social media and in public forums to determine if an investment community would be interested in learning more about the investment.

By using a test-the-waters safe harbor under certain sections of the Securities Act of 1933, companies can tweak their proposed investment opportunity prior to finalizing an offering circular—or to pivot in another direction.

The current entrepreneurial landscape presents an opportune moment to reevaluate your business strategy and sidestep potential pitfalls in raising capital.

This article does not necessarily reflect the opinion of Bloomberg Industry Group, Inc., the publisher of Bloomberg Law and Bloomberg Tax, or its owners.

Author Information

Rebecca G. DiStefano is member of Greenberg Traurig’s global corporate practice with focus on capital formation and securities compliance.

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