Your Business Financing Paper Trail

Proper fundraising requires carefully prepared documentation at every step. Here's what investors expect--and what the law requires.
Magazine Contributor
6 min read

This story appears in the March 2007 issue of Entrepreneur. Subscribe »

Even in today's fast-paced business world, raising money relies more on paper and ink than point-and-click. Whether you are looking for funds from a bank, a VC or just a rich uncle, it is crucial to communicate your ideas and plans on paper. And what a pile of paper! When done right, the fundraising process requires a dizzying array of forms, contracts, plans and projections.

And when it's not done right? Mistakes can lead to serious and long-lasting repercussions, as Cary Daniel learned several years ago. Daniel says he learned while working in a previous business how not to raise money. "In one angel deal, we raised $200,000, but later, additional funding was held up because we did not do the right documentation," says Daniel, 37. "It took the lawyers a month or two to fix what they [hadn't done right] a year [before]."

These days, Daniel doesn't cut corners. As CEO of Business District, Daniel assists more than 1,000 business brokers and entrepreneurs in buying, selling or financing businesses. Having the right applications and contracts available for his customers' financing needs is critical.

At the same time, Daniel is out on the fundraising trail himself. He and his partners put together more than $300,000 in startup capital in 2005 and 2006, and he is now seeking more than $1 million to turn Business District into a one-stop shop for anyone looking to buy, sell or finance their business. Fundraising is an arduous task, he admits, but one that has clearly defined steps. And each step requires its own unique set of carefully crafted documents.

David Gilroy of GrowthFinance in Charlotte, North Carolina, agrees. As a finance consultant and a partner in a VC firm, Gilroy has worked both sides of the funding table. According to Gilroy, fundraising documentation falls into two categories: marketing and legal.

Plans, Presentations and Projections
Because most initial communication between the business owner and investors will happen in cyberspace, Gilroy starts by crafting a concise e-mail that will introduce the concept in eight to 10 bullet points. "To just volley an executive summary over to an investor as an attachment is not a good plan," he says. "An intro in the body of the e-mail hits them front and center in their inbox."

Whether it is delivered by e-mail or not, investors expect to see an executive summary before anything else. That means a four- or five-page synopsis of the business plan. And as a follow-up, there's the business plan itself, of course.

The summary and plan form a broad overview of the business, Gilroy says, and should convey the potential of the business opportunity to the right investor. The document can be lengthy, usually 15 to 20 pages plus appendices with other marketing materials. This becomes the centerpiece for initial discussions between the investor and the entrepreneur.

Daniel says he chose to take an extra step and turn his business plan into a legal document called a private placement memo. "We may not have needed a full-blown PPM," he says, "but we wanted to assure future-round investors that the initial investors were accredited and informed."

If the business overview has enough sizzle, the investors will soon be asking for the steak. The meat of the deal should be presented in two key documents: a PowerPoint presentation and a financial spreadsheet model. Just as the presentation slides should illustrate both present and future business concepts, the financial model should give both historical financial data and financial projections.

There are no definite rules about how far into the future to plan. Daniel included three-year financial projections in Business District's current fundraising efforts. "But the further we go with experienced investors, I think five years [of projections] is more often required," he explains.

Term Sheets and Data Rooms
If you've found interested investors, expect them to seek out more information on your business and the opportunity. In the case of a formal offer to invest, they will include a term sheet--a simple document spelling out how the investor would like to proceed.

"The term sheet forms the overall framework for the deal," says Gilroy. "When it's signed by both sides, it creates the period of diligence and exclusivity."

That period of exclusivity gives the investor time to do detailed research into your company and market. To complete their due diligence, the investor will likely require yet more documentation from the business owner. Typically, all kinds of historical business documents are assembled and kept in a "data room." In the simplest cases, the data room may be little more than a binder of tax returns, bank statements and other documents. These days, data rooms of any size are often virtual, existing only on secure websites where documents are shared electronically.

Agreements and Articles
Assuming all goes well, Gilroy says, there are three cornerstones of the legal transaction that will cement the investment deal: a stock purchase agreement, an investor rights agreement and the revised articles of incorporation. Quite simply, the stock purchase agreement is the sales contract by which the stock of the company is exchanged for the investment capital. The investor rights agreement sets up the rules and responsibilities of each shareholder group (particularly when there are several classes of stock). And both of these documents will impact the fundamental articles of incorporation for the company, which, depending on the particular state laws, may describe how many shares are issued and how the company is governed.

"These documents all have schedules and representations and warranties, which in turn require [their own] schedules of exhibits," says Gilroy. "There are a lot of coattails, but the deal is defined around these documents."

In many cases, there may be other contracts to sign, such as employment contracts and a noncompete agreement for the CEO or executive team. If the investment includes a loan component, there could be a whole host of loan agreements and other representations related to the debt. Expect most sophisticated investors to take three to five weeks to complete due diligence and get agreements drafted.

No discussion of fundraising documents would be complete without a nod to Uncle Sam. When financing includes selling stock, be sure to consult with a securities attorney about complying with federal and state laws.

Of course, each deal is different, but all deals require respect for the documentation process. From business plans to regulatory filings, each document is a link in an important chain of events. Skipping any of the steps can invalidate the entire investment and trigger further legal complexities. Smart entrepreneurs will cross their t's and dot their i's.

David Worrell is author of the e-book Finding Funding.

More from Entrepreneur
Our Franchise Advisors will guide you through the entire franchising process, for FREE!
  1. Book a one-on-one session with a Franchise Advisor
  2. Take a survey about your needs & goals
  3. Find your ideal franchise
  4. Learn about that franchise
  5. Meet the franchisor
  6. Receive the best business resources
Use code MARKET2021 through 4/24/21 to save on 12 marketing books for entrepreneurs that are recommended by entrepreneurs:
  • Digital Marketing Handbook
  • No B.S. Guide to Direct Response Social Media Marketing
  • Ultimate Guide to Youtube for Business
  • And more
Discover a better way to hire freelancers. From business to marketing, sales, finance, design, technology, and more, we have the freelancers you need to tackle your most important work and projects, on-demand.

Latest on Entrepreneur