What Startups Need to Know About Raising Capital

As a founder, when you're deep in the fundraising trenches, the last thing you want to worry about is a tangle of regulations and contracts. But overlooking legal issues can derail your company before it even gets off the ground.

In this post, we’ll break down the most common types of startup funding and highlight the key legal considerations you need to understand.

The First Step: Seed Funding

The first round of startup financing is typically called the seed round (or pre-seed if your company is still in the idea or product development phase). If your investors are primarily friends, family, or close connections, it’s often referred to as a friends and family round. And while you may love each other—or, in the case of family, tolerate each other—failing to document the right legal structure from the start will come back to haunt you.

• Legal Tip: Document everything, even if it's a loan from Uncle Jerry. Without a clear agreement, things will get messy when future investors start asking tough questions about ownership.

At this stage, most investments come through convertible instruments like Convertible Notes or SAFEs (Simple Agreements for Future Equity).

Convertible notes are loans that convert into equity when a specific event occurs—usually when your startup raises a future round of funding. The conversion typically comes at a discount, meaning early investors get a better deal than those who invest later.

When thinking about convertible notes, keep in mind two key terms: the Interest Rate and Maturity Date. 

Interest Rate: Convertible notes accrue interest over time since they’re technically loans. That interest usually converts into equity along with the principal when the note converts.

Maturity Date: This is the date when the loan comes due. If your startup hasn’t raised another round by then, you may need to pay back the loan in cash or renegotiate the terms.

• Legal Tip: Pay close attention to the conversion terms. If the discount or interest rate is too steep, you could end up diluting your ownership far more than you planned.

SAFEs, on the other hand, are simpler than convertible notes. They don’t carry interest or a maturity date, making them easier to manage. Instead, they convert into equity in the future when a triggering event—like a Series A round—occurs. Because of their simplicity, SAFEs are generally more founder-friendly, but they also delay when investors see their equity.

• Legal Tip: While SAFEs are less complex, they can leave your investors waiting longer for their equity. Make sure the triggering event is well-defined to avoid confusion or disputes down the road

Angel Investors: Big Gains, Big Risks

Once you’ve completed a friends and family round, the next logical step is to approach angel investors. Angels are typically high-net-worth individuals who invest their own money in exchange for equity. They’re usually more willing to invest in early-stage companies when venture capitalists (VCs) are still sitting on the sidelines.

Since your company is in its early stages, angel investors often expect more favorable valuation terms to compensate them for the higher risk they’re taking on. But they can also bring more than just capital to the table—many offer mentorship, strategic partnerships, or valuable introductions.

However, this added involvement can sometimes complicate governance. It’s crucial to set clear terms in your investment agreements to avoid unwanted interference later.

Equity Crowdfunding

When raising capital from family or angels isn’t enough, you may turn to equity crowdfunding. This approach allows you to raise small amounts from a large pool of individual investors. Unlike donation-based crowdfunding (think Kickstarter), equity crowdfunding gives investors a financial stake in your company.

But equity crowdfunding is heavily regulated. Under Regulation Crowdfunding, companies can raise up to $5 million annually from retail investors. You’ll need to file detailed disclosures with the SEC, including financial statements and a business description. These filings are non-negotiable—non-compliance can lead to serious penalties, including fines and potential lawsuits.

• Legal Tip: Crowdfunding is not a “set it and forget it” strategy. SEC disclosure requirements are strict, and failure to follow them can expose your startup to significant risks. Make sure your financial statements are airtight before you go live.

4 Types of Investors Every Startup Founder Should Know

Venture Capital & Beyond

You’ve closed your seed round. Congratulations! As a reward, you now get to worry about raising even more money—this time, typically, from venture capitalists (VCs). While the money may be bigger, so are the expectations. 

Here’s what you need to know about the legal side of venture capital funding.

The Venture Process

VCs tend to invest much more than angel investors, but they also come with more strings attached. For example, VCs may ask for preferred stock or a seat on your company’s board of directors.

Preferred stock gives investors special rights over common shareholders. For instance, preferred stockholders often get paid first in the event of a sale or liquidation. They might also have veto rights over major company decisions. You’ll also hear terms like anti-dilution protection, which prevents VCs from losing value if your company issues more shares at a lower price in the future.

• Legal Tip: Don’t rush into a deal with VCs. Get your attorney involved early to ensure the terms are clear and to protect your long-term interests.

Series A vs. Series B, C, & Beyond

VCs often invest in Series A, which typically comes after a seed round. By the time you’re raising a Series A, you’ll need to have a strong product, clear market validation, and a roadmap for growth.

Series A rounds generally range from $2 million to $15 million. As you progress to Series B, C, and D rounds, the stakes get higher. These rounds typically involve larger sums, and as a result, more control shifts to the investors.

At this point, you may also consider venture debt, which allows you to raise funds without giving up additional equity. However, venture debt comes with repayment obligations, which can be risky for startups that are not yet generating consistent revenue.

• Legal Tip: Unlike many seed and pre-seed rounds, VC investments will typically be high-customized and negotiated. Be sure to consider important deal terms like, liquidation preference, dilution, governance, board seats, and inspection rights.

The Venture Process

Navigating the Funding Landscape: Your Next Steps

As we’ve explored, startup funding is filled with both opportunities and potential pitfalls. From friends and family rounds to venture capital deals, each stage of fundraising comes with its own set of legal challenges.

Remember: Securing capital is only part of the equation. How you structure these deals will determine your company’s long-term success. 

Stay informed, be prepared, and always approach fundraising with a clear understanding of the legal landscape. With the right knowledge and guidance, you can navigate the complex world of startup funding and set your company on a path to thrive!