Four Ways to Raise Capital and Attract Talent without Sacrificing Control of Your Business

Do you have a great idea but lack the resources to implement it? Almost every business in its early stages faces this dilemma. You are confident that your product, service, or business model is going to pay off, but you just do not have the initial capital to bring it to the market. After exhausting their personal savings and various bootstrapping methods, start-up owners are often forced to search for financing outside of their circle of family and friends.

In the modern marketplace, there are many ways to raise capital: angel investors, crowdfunding, startup accelerators, venture capitalists, private equity funds – the list goes on. However, one question that often bothers business owners most is: “How do I raise capital without sacrificing control over my business?”

This articles describes four ways you can receive access to resources without losing control of your company.

1. Debt

Choosing debt financing over equity financing gives a business owner a lot more control over the business. As long as you are making your payments on schedule, the bank will not bother you by telling you how to run your business. Debt financing may also be relatively cheap, especially if you can qualify for a loan guaranteed by the U.S. Small Business Administration (aka “SBA loan”). Although it takes time and effort to qualify and obtain an SBA loan, it can be a great way to infuse capital to your business without surrendering control. However, not many business owners are able to qualify for such loan because of lack of assets, experience, or income. If you are in a high-risk industry or are looking to bring a revolutionary idea to the marketplace, unfortunately, debt may not be an option for you.

2. Non-Voting Stock

Despite the fact that generally stock ownership is associated with a right to vote at shareholder meetings, it does not have to be. Corporations and LLCs are generally permitted to issue different classes of equity with different rights. Many times, an outside investor may be willing to let the owner retain the all of the voting rights in exchange for “preferred stock” that would give the investor a right to receive certain amount of dividend before the owner would be able to extract any profits from the company. This allows the outside investor to feel that they can protect their economic interests without interfering with the internal decision-making process. Although the non-voting stock arrangements provide a lot of flexibility, before using it you need to make sure that a shareholder or operating agreement clearly sets forth the rights of the “preferred stock” holders and the buy-sell formula which would allow you to buyout the outside investor should a conflict arise. Also, keep in mind that the law provides for certain minimum rights of shareholder, e.g. the right to reasonable access to the books and records of the company, that cannot be overruled by any agreement.

3. Convertible and SAFE Notes

These instruments are essentially a mix of debt and equity financing. A convertible note is a promissory note that provides lender with a right to have the note amount converted into equity at a certain discounted rate. Upon the issuance of the note, like any other note, a convertible note would not give the lender any right to control the company. Only when the company reaches a certain valuation cap or receives the next round of financing will the note convert into the actual stock of the company. A SAFE note is a creation of a Silicon Valley that is even friendlier to startup founders than a convertible note. SAFE (which stands for Simple Agreement for Future Equity) is essentially an option to acquire stock at a future time. Unlike convertible notes, SAFE notes do not bear interest and do not have a maturity date. The only right they provide to investors is to have their investment converted into equity at a discount and/or at a certain valuation cap. Due to their advantages over the convertible notes, the SAFE notes are becoming increasingly popular in the world of the early stage capital raise.

4. Phantom Stock

Phantom stock is not an instrument that can help you raise capital. It is, however, a great tool that may help you engage and retain talent. For some new businesses it is not capital that they desperately need. Rather it is attracting and preserving key employees: managers, key sales personnel, or an experienced CFO. One solution is to bring such key employees on board as co-owners. However, this raises many potential issues related to the control of the company and having to provide such key employees with access to the books and records of the company and shareholder meetings. Besides, you may already have a few partners on board, and having another shareholder to deal with is just not something you can afford. In such circumstances, a solution could be a phantom stock agreement. Phantom stock is not actual stock. Nor can it be converted to stock. All phantom stock does is providing to a key employee with a right to receive certain enumerated “quasi-shareholder” rights, such as a right to receive a payment or a right of first refusal to purchase shares in case of transfer of stock from the current shareholders. Because phantom stock arrangements are private agreement, their terms are very flexible and can be included in a written employment agreement.

Should you wish to discuss any legal issues related to raising capital or attracting or preserving talent, please contact the author of this article, attorney Roman Perchyts, at 224-836-6192 or rperchyts@lavellelaw.com.

This article is provided for informational purposes only and does not constitute legal advice. You should not rely on the information contained in this article without first consulting a licensed attorney.