Startup Financing and the Legal Implications of Equity vs. Debt Financing

While both equity and debt financing have the potential to fuel the growth of your company, each option comes with distinct risks. It is important for founders to understand the difference and to consult with a corporate lawyer before committing to financing to avoid costly mistakes.

What is Equity Financing?

Equity financing involves the selling of an ownership stake in your company in exchange for capital. Think of what happens when investors on Shark Tank bid for partial ownership of entrepreneurs businesses to the sharks. Common vehicles to transfer company interest in exchange for capital is common stock, preferred stock, convertible notes and SAFEs (Simple Agreement for Future Equity).

Legal Considerations of Equity Financing

Sales of equity in a business must comply with state and federal securities laws. Further, equity financing dilutes the ownership of founders and diminishes their voting power, depending on the type of equity transferred to investors. Additionally, the sale of equity will likely require the updating of corporate documents, such as bylaws, shareholder agreements and operating agreements. Finally, a company must disclose material risks and company financial information- especially in larger or institutional rounds.

What is Debt Financing?

Debt financing is exactly what one would think; borrowing money with a legal obligation to repay it, typically with interest on the principal. This type of financing usually occurs through business loans or lines of credit, credit cards, revenue-based financing, promissory notes and convertible notes.

Legal Considerations of Debt Financing

Repayment terms on these loans always require a business to repay principal + interest on a fixed schedule, regardless of cash flow and profits. Further, lenders may require personal guarantees of founders in their personal capacity on debt financing loans. Further, missed payments can trigger accelerated repayment, penalties, or even asset seizures. Finally, agreements for debt financing may impose contractual restrictions on obtaining further financing.

Whatever route your company goes, always have a corporate lawyer review debt financing agreements or equity financing agreements before a company enters into such agreements.

Get a Business Attorney

Whether you’re bootstrapping, courting angel investors or preparing for venture capital, choosing the right financing method is a legal and strategic business decision. Utilize a business lawyer who understands startup dynamics and can help you comply with the law, prepare for investor due diligence, structure agreements and protect your company equity.

Are you interested in getting a contract review, contract drafted or handling another business legal matter?  We’re here to help. Quick turnarounds and no surprises.

Contact Biazzo Law today at (703) 297-5777 or alyssa@biazzolaw.com to schedule a consultation today. www.biazzolaw.com 

** Information in this blog should not be considered legal advice, nor does it form an attorney-client relationship

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