Part 1: A legal guide to startup fundraising in Malaysia
In a 6-week series, Izwan Zakaria, the Managing Partner of Izwan & Partners will be covering legal topics and trends affecting technology entrepreneurs and startups.
In this first part, Izwan has listed the things founders should know before fundraising for their startup in Malaysia. Part-2 arrives next Wednesday.
Fundraising is one of the challenges that startup founders need to go through in their entrepreneurial journey in growing an early-stage startup. Fundraising is a regulated activity in most or all countries.
Different countries have laws that need to be satisfied to ensure that your fundraising is within the law. Here are a couple of things that founders should know before getting on with the fundraising process in Malaysia.
1. Sort out your internal affairs
Before you even start pitching to potential investors, make sure you sort out your internal stuff. I’m talking about people involved in your company like your co-founders, advisers, including your team members. For instance, if you’ve agreed to give out shares to your team members in exchange for their time to the company, make sure you get the paperwork sorted now before you start your fundraising.
If you’ve got a founder’s vesting between the other co-founders, get that sorted too. Yes, I’m talking about now, not tomorrow or next week.
No investors want to inherit your internal and outstanding issues or even legal problems, so you better get them fixed before bringing other third parties like investors in the company.
2. Decide on a fundraising option or method
A startup can raise funds by selling shares in the company or by taking up loans or debts.
Selling shares means getting investment into the company in return for shares to the investor. You can do this by doing closed-door pitches to potential investors in your network or referrals.
Another option that is more popular now is by hosting a crowdfunding campaign. They are ten equity crowdfunding platforms by the Securities Commission of Malaysia so you can choose one that suits you best.
Another option is for early-stage companies where the company borrows money from investors or banks (quite frankly, unheard of). In this scenario, the company may also need to put up collateral like a piece of land or other valuable assets like a patent. Suppose your company is in the trading business where you get recurring invoices from suppliers or reputable customers.
In that case, you may borrow money using peer to peer (P2P) platforms to cover the working capital costs. Venture debts may be another option under this category. But venture debts usually work well in a company that tends to be more mature and revenue-generating with some level of cash flow to repay the loan (or else why would the lenders lend you money in the first place).
An example will be Carsome with actual hard assets like used cars on its assets inventory since they are involved in the used car sales space.
In any case, you should sit down and carefully map out your fundraising plan. The point I'm trying to make is entrepreneurs should think of more creative ways to raise funds.
All in all, please consider if you need to sell your company’s shares to raise funds. Know that ‘equity is the most expensive form of capital’. Most new entrepreneurs I talk to adopt equity investment as the ‘default path’ without looking at other fundraising options.
If you are a new founder, it may be useful to have a few trusted seasoned entrepreneurs as your startup advisers to help you avoid major pitfalls that can be disastrous down your fundraising journey.
If you are involved in making products or even in some services, you may want to consider reward crowdfunding like Kickstarter and Pitchin to raise funds too. A great example would be how the Oxwhite guys started pre-order sales and how they’ve managed to sell 10,000 shirts.
So instead of selling shares to raise funds to buy the products, you can get your customers to help fund your initial business before you become revenue-generating.
Another fundraising path that founders tend to neglect is funding agencies like Cradle Fund and even accelerators like Selangor Accelerator Programme. The application process can be lengthy and even onerous but it’s a great way to get money without giving away your precious equity.
3. Agree on the commercial investment terms
Before we even get started with the paperwork needed to start fundraising, you should spend some time to read and understand the different commercial terms involved in raising capital. This may also be a good time to get a commercial lawyer with experience in capital raising for early-stage startups to pinpoint the critical terms you should be looking at to offer investors.
Here are the usual commercial terms that you should come up to a consensus with the investor when it comes to receiving the investment:
● The investment instrument like ordinary shares, preference shares (know the differences of preference shares (including its different characteristics like cumulative, redeemable, convertible, liquidation preference etc. and the different legal impacts on your company), other instruments like a convertible note, SAFE, KISS etc
● The total fundraising amount
● The manner and how the investor will invest in your company (whether the funds will be 100% drawdown lump sum or based on specific periodical dates or even certain performance milestones)
● Details of your company’s current valuation (usually known as the pre-money valuation) and post-money valuation
● The amount and percentage of equity that you are offering to the investor.
In a Silicon Valley-style, it may be common for companies to have unpriced financing rounds (basically an investment that doesn’t come with a valuation).
The usual unpriced fundraising rounds include SAFE (Simple Agreement for Future Equity from Y Combinator style) or convertible note like KISS (Keep It Simple Securities by 500 Startups).
In Malaysia, most pre-seed and seed investment rounds still tend to be the direct vanilla equity investments in return for shares in the company. I won’t get into detail the nuances between priced and unpriced financing rounds this time since this post is more focused on Malaysia’s fundraising process.
Ultimately the fundraising boils down to the complexity of the commercial terms. The fundraising’s technicalities, including the choice of investment instrument, usually boils down to the investor’s expectations of the company whether the investor is seeking certain immediate financial returns (usually preference shares) or a strategic and long-term investor (usually ordinary shares).
If your investor is a sophisticated investor like institutional, corporate or venture capitals, you may have more commercial terms involved. The terms may vary significantly compared to a seed round by an angel you raise in small families and friends rounds. So you should take some time to learn the characteristics of the investor so that you know their investment goals when they decide to invest in your company.
In my experience, dealing with venture capitals tends to be generally more straightforward since you know that they are looking for financial returns in your company as opposed to angels that may be looking at something more strategic or subjective reasons.
Once you’ve agreed on the terms, they will get included in a final investment term sheet agreed upon by the investor and the founders. The parties involved are the existing shareholders of the company, including the company receiving the investment.
4. Pitch for an investment
Unlike an initial public offering or an IPO (where a company offers its shares to the public for the first time in a stock exchange), shares in a private company are not open to the public. In other words, fundraising is strictly a discreet activity that cannot be like a huge gala event because fundraising is a regulated activity in most if not all jurisdictions.
However, in Malaysia, you may consider raising funds for your company legitimately more openly and flexibly using regulated platforms like equity crowdfunding and P2P platforms regulated by the Securities Commission of Malaysia.
If you are hosting a campaign on a crowdfunding platform, they are minimum disclosure guidelines involved including the platform agreements you need to sign with the platform operators. Make sure that you don’t misrepresent your pitch deck or business plan like saying you have this customer or that contract that may not be true or even exist.
Even though the same disclosures may not be necessary if you fundraise on your own, investors can still sue you for lying to them if they relied on your facts that turned out to be false. It is also embarrassing and will affect your reputation as a founder and entrepreneur.
5. Get an investment term sheet, or come up with one
Now that you’ve managed to land on an investor, the next step is to sign an investment term sheet. As a general rule, the investor will issue an investment term sheet setting out their investment terms in your company.
But if you are raising from less sophisticated investors like families and friends round or even most angels, you may need to come up with your investment term sheet to these investors. So it may be useful to get a commercial and startup oriented lawyer to help you come up with one.
Izwan Zakaria is the Managing Partner of Izwan & Partners, a corporate and technology law firm. He is also the author of The Startup Law Blog, a website covering legal topics and trends affecting technology entrepreneurs and startups in Malaysia. He can be contacted on Twitter at @izwanzakaria1 or email at email@example.com.
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