How to structure financial relationships with investors:

How to structure financial relationships with investors: a comprehensive guide to financial instruments

Loan

A loan is a traditional financial instrument where an investor provides a startup with funds for a specific period at a fixed interest rate. At the end of the loan term, the company must repay the principal amount along with interest.

Advantages:

• Clear terms: Well-defined repayment conditions and interest rates.
• No dilution: A loan does not affect shareholders’ equity in the company.

Disadvantages:

• Repayment obligation: The necessity of regular payments can create financial pressure on the startup.
• No management participation: The investor does not gain the right to participate in the management of the company or key decision-making.

Startup equity investments

Startup equity investment involves an investor acquiring a stake in the company. In exchange for their funds, the investor receives shares, granting them a right to a portion of the profits and participation in management.

Advantages:

• Long-term benefits: Potential for substantial returns if the company succeeds.
• Management participation: Often accompanied by voting rights and influence over key decisions.

Disadvantages:

• Dilution of ownership: Raising additional capital may lead to a reduction in existing shareholders’ equity.
• Company risks: The investor faces risks if the company fails to meet expectations.

These two instruments represent the most traditional methods of funding startups. The choice between them depends on the stage of your business and how willing you are to share control of the company or burden it with debt obligations.

Partnership agreement

A partnership agreement is a legal document, not a financial instrument. While it is not a standalone financial instrument, it plays a crucial role in establishing the terms of collaboration between founders and investors.

The partnership agreement serves as the foundation for creating long-term and deep business relationships between the founder and the investor. It anticipates the investor’s active participation in the management of the company and strategic decision-making. The agreement details the rights and responsibilities of both parties, including profit distribution, potential conditions for additional investments, and company management.

Advantages:

• Active participation: The investor can directly influence strategic decisions.
• Long-term relationship: This creates a strong foundation for cooperation.

Disadvantages:

• Limited freedom: This may reduce the operational independence of the founder.
• Conflicts of interest: Possible disagreements over management.

Simple agreement for future equity (SAFE)

A simple agreement for future equity streamlines the capital-raising process by allowing investors to receive shares in the company based on future valuation. This instrument is particularly suitable for early-stage startups, where determining a company’s valuation can be challenging.

Advantages:

• Simplicity and flexibility: Avoids complex negotiations over company valuation.
• Deferred valuation: Company valuation occurs in the future.

Disadvantages:

• Uncertainty: Valuation and conversion terms will be defined in future rounds.
• Dilution risk: Possibility of reducing existing shareholders’ equity.

Revenue-based financing

Revenue-based financing allows startups to raise capital in exchange for a percentage of future revenues. This is an ideal instrument for companies with strong revenue streams that want to avoid traditional debt or equity dilution.

Advantages:

• Repayment flexibility: Payments depend on the company’s revenue.
• No Immediate dilution: No immediate increase in share count.

Disadvantages:

• High cost: Long-term costs can be significant.
• Regular monitoring: Requirement to provide regular financial reports.

Put Option Agreement

This instrument allows the investor to acquire shares in the company, granting the right to sell them back at a predetermined price in the future. This gives the investor an exit option if the company does not meet performance targets.

Advantages:

• Investor protection: Ability to exit the investment.
• Incentivizes founders: Motivates the founder to work towards increasing the company’s value.

Disadvantages:

• Pressure on the company: Challenges in establishing future pricing and repurchasing shares.
• Valuation limitations: difficulties may arise in accurately valuing shares.

Tokenized financing

Tokenized financing involves the utilization of cryptocurrency tokens for capital raising. There are two main types: Initial Coin Offering (ICO) and Security Token Offering (STO). ICO involves issuing new tokens, while STO offers tokens representing securities.

Advantages:

• Global access: Ability to attract international investments.
• Liquidity: Tokens can be traded on cryptocurrency platforms.

Disadvantages:

• Regulatory risks: Need to comply with local and international regulations.
• Technical risks: Management and security of tokens.

In addition to the aforementioned instruments, other tools are also used, such as:

• Convertible Note
• Venture Debt
• Preferred Shares
• Convertible Equity
• Contingent Convertible Bonds (CoCos)
• Revenue Participation Loans
• Bonds
• Credit Lines
• Stock Options
• Venture Capital
• Convertible Bonds
• Mezzanine Financing
• Royalty-Based Financing
• Warrants
• Initial Coin Offering (ICO)
• Security Token Offering (STO)

Choosing the right instrument and funding terms is critical for the success of your startup. Each agreement should consider the specifics of your business and strategic goals.

Finetic Consulting is ready to offer tailored solutions for your startup, whether it involves raising capital through loans, equity purchases, or other financial instruments. Our experts will help develop agreements that consider all the specifications and needs of your business. Contact us to discuss how we can help you achieve your business goals and build successful investor relationships.