Capital Raises & Investment

Raising capital is how companies fund growth. Whether it is a founder raising seed capital from angel investors, a growth-stage company bringing in institutional investors, or an established business raising equity to fund an acquisition, the legal framework is the same: the Corporations Act 2001 (Cth) regulates how securities are offered, what disclosures must be made, and what rights attach to the securities issued.

Getting the structure right protects both the company and its founders. Getting it wrong can mean giving away too much control, accepting terms that create problems on the next raise, or inadvertently breaching the fundraising provisions of the Corporations Act.

At its simplest, a capital raise involves the company issuing new shares (or other securities) to investors in exchange for capital. The company receives funds to invest in the business. The investors receive an ownership interest and, depending on the terms, certain rights including the right to appoint directors, approve major decisions, receive information and participate in future rounds.

The terms of the investment are typically negotiated through a term sheet, which sets out the key commercial terms before the parties move to full documentation. The term sheet is usually non-binding (except for provisions like exclusivity and confidentiality), but it establishes the framework for the investment and is the document around which the negotiation revolves.

Ordinary shares are the most straightforward form of equity. Each share carries the same rights to vote, receive dividends and participate in a distribution of assets on winding up. Most early-stage raises involve the issue of ordinary shares.

Preference shares carry preferential rights over ordinary shares, typically a preferential right to dividends, a liquidation preference (the right to receive a return of capital ahead of ordinary shareholders on winding up or sale), or both. Preference shares are common in later-stage raises where investors want downside protection.

Convertible notes are debt instruments that convert into equity at a future date, typically on the occurrence of a qualifying event such as a subsequent equity raise. The conversion price is usually set at a discount to the price paid by investors in the qualifying round, reflecting the risk the note holder took by investing earlier. Convertible notes allow the company and the investor to defer the question of valuation to a later date.

SAFE agreements (Simple Agreement for Future Equity) are similar in concept to convertible notes but are not debt. They give the investor the right to receive equity in a future round at a discount or subject to a valuation cap. SAFEs do not accrue interest and do not have a maturity date. They are common in seed-stage raises.

The terms that matter most in a capital raise, and that are most frequently the subject of negotiation, include:

Valuation and price. The pre-money valuation determines how much of the company the investor will own after the investment. A higher valuation means less dilution for existing shareholders. A lower valuation means the investor gets more of the company for the same amount of capital. This is the central commercial negotiation in any raise.

Anti-dilution. Anti-dilution provisions protect the investor if the company raises capital in the future at a lower valuation (a "down round"). The most common forms are full ratchet (which adjusts the investor's conversion price to the lower price, providing maximum protection) and weighted average (which adjusts the price based on the relative size of the down round, providing more moderate protection).

Pre-emptive rights. The right of existing shareholders to participate in future capital raises on the same terms as new investors, in proportion to their existing shareholding. Pre-emptive rights prevent dilution and are standard in most shareholder agreements.

Board representation. Investors frequently negotiate the right to appoint one or more directors to the company's board. This gives the investor a direct role in the governance and strategic direction of the company.

Information rights. The right to receive regular financial and operational information about the company. Investors need information to monitor their investment. The company needs to balance transparency with the administrative burden of reporting.

Drag-along and tag-along. Drag-along rights allow the majority shareholders to force all shareholders to sell in a trade sale, ensuring a buyer can acquire 100 per cent of the company. Tag-along rights allow minority shareholders to participate in a sale on the same terms as the selling majority. Both are important for ensuring a viable exit pathway.

Restrictive covenants. Investors will typically require the founders to be subject to non-compete and non-solicitation obligations for a defined period, protecting the value of the investment.

Chapter 6D of the Corporations Act imposes disclosure obligations on companies that offer securities. The general rule is that a company must issue a disclosure document (a prospectus, offer information statement or profile statement) before offering securities.

However, most private capital raises rely on exemptions from the disclosure requirements. The most commonly used exemptions include:

Section 708(8): sophisticated investors. The offer is made to a person who has net assets of at least $2.5 million or gross income of at least $250,000 per annum for each of the last two financial years, and the person is given a certificate by a qualified accountant confirming this.

Section 708(10): professional investors. The offer is made to a person who is a professional investor, which includes Australian financial services licensees, bodies regulated by APRA, and persons who control at least $10 million.

Section 708(1): small-scale offerings. The company makes personal offers to no more than 20 people in a 12-month period, and the total amount raised does not exceed $2 million. This exemption has specific conditions and requires careful compliance.

Relying on an exemption without satisfying its conditions is a contravention of the Corporations Act and can result in the investor having a right to withdraw from the investment and recover their money.

Capital raises can shift the balance of power in a company. Founders who are not careful about the terms they accept can find themselves diluted to a minority position, subject to restrictive vesting arrangements, outvoted on their own board, or locked into the company without a viable exit.

Founder protection mechanisms include vesting schedules that apply equally to all shareholders (not just founders), control thresholds that require founder consent for major decisions, anti-dilution protection for founders as well as investors, and clear exit mechanisms that give founders a pathway to realise value.

The time to negotiate these protections is before the investment closes, not after.