Choice of Business Entity for a Startup
In Canada business entities considered by entrepreneurs include: (1) sole proprietorships, (2) partnerships and limited partnerships and (3) corporations. Each of these entities has advantages as well as disadvantages. Choice of the entity is usually not irrevocable, and often an initial decision will be made with the understanding that, at the appropriate time, a different form of organization will be used.
Protection of Intellectual Property in a Startup
Aside from competence of management team, control of intellectual property is a major focus of investor scrutiny. The ability to identify and protect intellectual property directly reflects on investor confidence and the resulting access to capital available to technology start-up. Protection of intellectual property assets is available through the law of copyright, trade secrets, patents and trademarks.
Sources of Initial Financing
The first place many entrepreneurs get money from is themselves. Entrepreneurs must be personally and financially committed to the startup. Many entrepreneurs mortgage their homes, cash RRSP, and use credit cards to finance the initial operations of the business. Access to these sources of capital may be critical to a startup, but they come at a high emotional and financial cost. After entrepreneurs exhausted their personal financial resources, they usually turn to their friends and family for financing assistance. Institutional investors, however, are hesitant to fund startups owned by a large number of individual investors or companies controlled by family members. If the business fails, and the probability of that is high, the friends and family will lose their investments. Failure invariably strains relationships. By adding multiple investors, an entrepreneur adds complexity, such as holding management meetings and potentially losing control of the startup business.
When traditional venture capital firms refuse to lend, a startup turns to individual private equity investors known as "angels". In addition to moneys, angels also bring expertise and experience to a startup and may serve on the board of directors or provide guidance through consulting or mentoring. Angels risk their capital based on their experiences and instincts. They tend to invest together with trusted friends and associates or on the recommendation of service professionals. They are capable of investing quickly (30-60 days to a closing) and their due diligence can be less rigorous than venture capitalists or strategic investors. Angels may buy into concepts of a startup and be forgiving on valuation. A single angel's participation in an investment usually ranges from $25,000 to $250,000.This informal investment market tends to be regional – Ottawa, Toronto and Waterloo. Angels are not listed in directories and they are hard to find, thus, raising this type of seed capital involves a costly and time-consuming networking process for entrepreneurs.
Private placements, another traditional source of financing, consist of the offer and sale of equity or debt securities in an offering exempt from many of the more complex federal and provincial securities laws. Private placements are an attractive source of equity capital for a startup company that for some reason has ruled out possibility of going public. If the goal of a startup company is to raise a specific amount of capital in a short time, this equity source may be the answer. In this transaction, the company offers shares to a few private investors, rather than to the public as in a public offering. In order to qualify for any securities law exemption, most private placements are restricted to institutional investors and wealthy individuals known as accredited investors.
Banks are a major source of both short-term and long-term funding for many conventional companies. Through borrowing, an entrepreneur is able to acquire the funds he needs to operate his business without giving up control of a business. For startups the principal problem with bank borrowing is that, in addition to charging interest, banks require borrowers to adhere to very strict operating standards to keep the loan in a good standing. The pressures of operating in such an environment can outweigh the benefits, particularly for a startup that may experience difficulty being confined by external restrictions imposed on its changing business models.
Venture capital can generally be categorized as high risk, usually equity (or convertible debt) capital provided to startups by high net worth individuals and institutions who take an active interest in a company. The venture capital industry is highly competitive on the supply side, especially when a promising company is involved. The venture capital industry is attracting substantial amounts of money, and venture capital firms compete not only among themselves, but with other investors, including "angels" and corporations, such as Adobe, Intel, Cisco, Informix and Netscape. Venture capitalists also compete with other forms of startup financing, including "bootstrapping," commercial lending and public equity markets.
A potential way to avoid the pitfalls of "friends, fools, and family" money is for a startup to secure its seed capital from the government. Both Federal and various provincial government agencies fund organizations which help finance small businesses in a variety of ways, including (i) the issuance of a direct financial award (more typical among provincial organizations), (ii) the extension of a low-rate loan and/or (iii) the guaranty of a commercial bank loan.
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