Introduction: The Funding Landscape
Raising your first investment round is hard work. Founders often spend months cold-emailing investors, refining pitch decks, presenting to rooms of sceptics, and navigating the long road of due diligence.
Since the tech downturn of 2022 and the subsequent rise in interest rates, securing funding has become even more competitive. Investors are increasingly focused on capital efficiency, credible paths to profitability, and viable exit strategies.
So when a term sheet finally lands in your inbox, it can feel like you’ve crossed the finish line. In reality, the real legal work is just beginning.
Understanding the legal fundamentals at this stage can save you significant time, money, and frustration, and ultimately help you stay focused on growing your business.
Here are some key legal considerations to keep in mind as you raise your first round.
Choosing the Right Structure for Your First Round
Most early-stage funding rounds fall into one of four categories:
- Priced Equity Rounds
- SAFEs (Simple Agreements for Future Equity)
- Convertible Loan Notes
- Advanced Subscription Agreements (ASAs)
Broadly, the last three are considered “Advanced Fundings”: investments made ahead of a future equity round, typically converting into shares later (often within 3–12 months).
These structures are popular in very early rounds because they typically avoid the need to agree a valuation upfront. They’re usually faster to close, involve less legal work, and usually come with lighter due diligence. However, they often include conversion discounts (e.g. a 20% discount on the price of the next funding round) and, in the case of convertible notes, may accrue interest.
Priced Rounds, on the other hand, offer clarity from day one. Investors purchase shares at an agreed valuation, setting ownership percentages from the outset. The trade-off is complexity. You’ll likely need to update your articles of association, enter into a new shareholders’ agreement and investment agreement. These documents usually contain warranties, founder covenants, investor consent rights, and information obligations – all of which require substantial negotiation.
Your early investors could include friends and family, angels, or even an early-stage VC. Early-stage VCs (also known as institutional investors) often seek greater control and broader rights from the outset. Angels, by contrast, may focus on high-level protections with the expectation that VCs will take the lead in future rounds.
Legal Due Diligence: How to Prepare
Once a term sheet is signed, investors are likely to conduct legal due diligence. The extent of the diligence will usually depend on the nature of the investor, their risk tolerance and the investment size.
To streamline this process, prepare a data room in advance (Dropbox or Google Drive works fine) containing key company documents. Suggested contents include:
- Key customer and supplier contracts
- Employment templates and founder service agreements
- Loan agreements
- Existing articles and shareholders’ agreement
- A summary of intellectual property (with evidence of ownership)
- A summary of any material disputes
Investors don’t expect everything to be perfect at this stage. In fact, many use diligence to help shape areas of improvement post-investment. That said, having strong founder service agreements, with clear IP assignments, appropriate notice periods, and enforceable restrictive covenants, can reduce the risk of these agreements having to be amended pre-closing.
Common Mistakes (and How to Avoid Them)
One of the biggest mistakes founders make is signing a term sheet without first seeking legal or experienced advisory input. Once signed, reopening commercial terms can be difficult, especially if legal advisers weren’t involved from the start.
If you’re not ready to engage a lawyer, at least run the term sheet past experienced contacts, such as a trusted NED or someone from your accelerator or network, before you sign.
Another common trap is misunderstanding exit economics. A high valuation might feel like a win, but preference shares, liquidation stacks, and coupons can significantly erode founder proceeds. A combination of these often means investors get paid ahead of founders and ordinary shareholders at exit. The larger the preferences, the higher the sale price needs to be before founders see meaningful returns. I strongly recommend modelling different exit scenarios based on these terms and using realistic valuations. You may be surprised how little you stand to gain unless the exit is substantial. I’ve seen this go badly for founders more than once.
Investors may often tell you that their terms at “market standard”. If you get the chance, have a look at HSBC Innovation Banking’s term sheet report. It is free and can be found online. This provides a helpful benchmark to verify whether certain terms are truly standard.
What Founders Often Don’t Expect
Equity isn’t the only thing you give up when raising investment. Most investors will also require a degree of control. Common requests include a board seat and veto rights over certain company decisions.
These provisions aren’t unusual, but you should try to ensure you keep board and operational control for the meantime. You can often achieve this by balancing the board with additional founder seats or using weighted voting, and by narrowing investor consent rights to only high-level, strategic matters.
Another common ask is founder vesting. The idea is that you should earn back your equity over time. A typical structure is four-year vesting with a one-year cliff. For example, if you leave after two years, you retain only 50% of your shares.
While founder vesting can be an emotional point for founders, investors often see some kind of reverse vesting as essential. Their rationale is simple: you’re often the key reason they’re investing. If you leave, the business may lose much of its value. The founder staying and growing the business are inextricably linked.
To mitigate this, founders often negotiate for a shorter vesting period or to exclude a portion of their shares from the vesting schedule altogether. This makes sense, as founders will have already spent a substantial amount of time building the company from scratch.
Final Thoughts
Raising your first round is a major milestone, but it’s crucial to be prepared, protect your interests, and avoid letting the legal process overwhelm or delay your progress.
Take the time to understand your options, get your documents in order, and seek the right advice. With the right preparation, you can close your round confidently and efficiently and stay focused on building the business you’ve worked so hard to start.
Good luck on your fundraising journey!
