Earlier this month, a Ghanaian Financial Technology (Fintech) start-up “Float” was reported to have raised $7million equity and $10million debt during a seed round.This follows a similar seed round of $35million raised by a Ghanaian health tech start-up “mPharma” earlier this year. These successful seed rounds are indicative of a growing start-up ecosystem with scalable and viable business ideas worth investing in.
While many young people continue to leverage the disruptive influence of technology to design products and services, they will require funding to support the development, growth, and expansion of their start-ups. However, there are regulations in place that determine which funding options are permissible and can be used to raise funds.
In Ghana, private companies are prohibited by the Companies Act, 2019 (Act 992) from making an invitation to the public to acquire shares (equity) or debentures (debt) and to deposit money for fixed periods or payable at a call whether bearing or not bearing interest. These prohibitions limit a private company’s ability to raise initial capital and/or engage in additional fundraising initiatives to support its operations.
Nonetheless, some permissive fundraising options such asprivate placements, right issues, capitalization issues, conversion, and going public through initial public offers (IPOs) exist and can be leveraged by start-ups to make available critical funds required to grow and expand geographically.
This article seeks to discuss some of the permissible means of fundraising options start-ups can use to raise funds from local and global sources.
FUNDRAISING THROUGH PRIVATE PLACEMENTS
Private placements involve direct offers (involving the circulation of pitch decks) to investors (individuals or entities) to acquire equity in or extend debt financing to a private company. These invitations could be extended to a group of investors by a private company or on its behalf by a private equity firm. An essential requirement is that such invitations should not be publicized or advertised as that will be in contravention of the prohibition of making an invitation to the public to acquire shares or debenture. Also, the number of investors that can invest in return for shares through these private placements cannot be more than fifty in total at a particular time. Detailed information necessary to help investors make informed decisions are required to be disclosed. However, entrepreneurs must take steps to protect confidential and proprietary information through the execution of non-disclosure agreements prior such disclosuresand be prepared to be subjected to rigorous due diligence in most cases.
An entrepreneur/start-up seeking to raise funds through private placement can leverage any of the following seed fundraising rounds:
a. Pre Seed Funding
In the startup’s early stages, funding is usually gathered informally. Pre-seed funding is at the very beginning of the startup’s launch. Founders start by investing their own money (bootstrapping) or seek assistance from friends and family for formative capital which are expected to be repaid within a reasonable time.
Getting a business idea off the ground is the hardest part, as it takes the most work with the littlest investments. During the pre-seed stage, a start-up is mostly still in the market research stage and without any tangible product or service. The business model is still being developed; thus, investments are still at high risk. While there is still little proof of profitability, it is very rare to receive funding from venture capitalists or angel investors unless one has a strong network and a scalable or viable business idea.
b. Seed Funding
An early effort by a start-up to raise funds to grow is through “seed” funding. Funds from this round are usually used to finance a start-up’s initial market research, product development, create value, and to employ personnel to drive its growth. New opportunities for funding at this stage include start-up incubators and accelerator programs, early-stage venture capitalists, and crowdfunding. Mostly, funding is exchanged for equity stakes in start-ups.
Simple Agreement for Future Equity (SAFE) is one of the instruments used in securing investors’ equity interest at this stage. A SAFE provides investors with a right to future equity and converts on agreed milestones usually before the next funding round of the start-up. Funds raised at this stage could be significantly high and may be the only funding required to make the start-up successful.
Valuations are conducted at this stage (the reason it is sometimes called the “priced” round) and take into account the start-up’s market operation – products and customer base, market share, revenue, and profitability. From the valuation, the total start-up value, total money to be raised, and post-money values are determined.
The following funding rounds could be undertaken during seed funding:
i. Series A
With significant evidence of an established product/service and customer base, growing revenues, growing market share, among others, a start-up may opt for Series A funding. At this stage, investors are interested in how the start-up will navigate and expand its market, strategies to grow and increase revenue. Therefore, funds raised are mostly used to improve product offerings, support channel development activities, and gain market shares. Investor participants at this stage could include venture capitalists, angel investors, and investments from crowdfunding platforms. In recent times, start-upsparticipating in Series A rounds have been able to raise between $2million to $10million.
ii. Series B
Before a start-up can opt for a Series B funding round, it must have demonstrated that it has an established and validated product or service offering. During this round, a start-up seeks funding to increase its reach and customer base following substantial market development based on earlier Series A funding round. Further, investments into sales and marketing, technology, business development, human resources, and capacity building initiatives, are the key goals of raising substantially huge funds associated with this round with minimum valuations at $30million. Later-stage investing firms drive investments for this round.
iii. Series C
Series C funding round is only available to start-ups that have proven successful, well established, and with a sustainable business model. At this stage, the reasons for raising funds will be to help the start-up expand into new geographical markets, develop a new line of product/service or acquire or merge with other start-ups for competitive market advantages. Also, funds may be used to scale up and attain a global presence. The capital outlay is huge demanding valuations based on the historical performance of the start-up in terms of revenue, profitability, customer base, market share among others than on future assumptions of good performance. This round attracts hedge funds, investment banks, and other large secondary market investment groups with huge funds, networks, and excellent professional expertise. It is not uncommon for start-ups to raise up to $100million plus in this seed round.
CONVERSION – DEBT OR PROMISED EQUITY
Through private placements, a start-up may be able to secure a debt financing arrangement with a conversion option(debenture) or commit to future equity (through the use of SAFE) in exchange for immediate funding. Underlining these funding arrangements is the promise of conversion into equity. Generally, conversion into share ownership (equity) will occur on an agreed contingent event. Once conversion occurs, lenders will become a shareholder of the start-up.
These sources of funding are not repayable reducing any debtfinancing commitments and allowing re-investment of cashflows into start-ups. Start-ups can use the funds raised to support their growth and expansion and reward lenders/investors with participation in ownership at a later date.
RIGHT AND CAPITALISATION ISSUES
Although right and capitalization issues are other permissible options for raising funds, the nature of start-ups makes them impracticable for use. Mostly, start-ups are founded by entrepreneurs with little or no money and who will not be in a position to invest additional capital through a right issue.Further, because start-ups are generally not profitable at their early stages, they are unable to retain earnings (reserves) to facilitate a capitalization issue as well.
INITIAL PUBLIC OFFERS (IPOs)
Raising funds through an IPO implies the legal conversion of a private company into a public one. By this, the shares of start-ups will be offered to the public for purchase and ownership.
An IPO process is expensive, complex and requires the service of professionals such as underwriters, lawyers, accountants, and others to prepare the required prospectus among others. Further, these professionals help start-ups to determine the value of the company, the type of shares to be issued, the number and price per share, etc.
Start-ups must also comply with strict legal requirements onthe conversion of a private company into a public one. Nonetheless, entrepreneurs may use IPOs as means of either raising huge capital or as an exit strategy to dilute their ownership and control.
MERGERS AND ACQUISITIONS (M&A)
Mergers and acquisitions are more business survival, growth, and expansion strategies than fundraising options. However, through an M&A, start-ups will be able to consolidate their product or service offerings, revenue streams, increase customer base and market and attain a near-monopoly status depending on the type of integration, an M&A process seeks to achieve. With this, new investments are injected into the operations of the new company with sustainable improvements in liquidity, products or services, and technology.
Lack of business ideas is not one of the challenges facing Ghana’s start-up ecosystems. How to raise requisite funds to develop ideas into viable businesses with relevant product/service offerings continue to slow the growth rate of many start-ups. Therefore, understanding fundraising options available for start-ups is critical information every entrepreneur must have before their decision-making on raising funds. Whilst some of these fundraising initiatives demand incorporation of start-ups in preferred jurisdictions like Delaware, the opportunity to use a Ghanaian incorporated start-up to raise money using any of the above-discussed tools also exist, and therefore an understanding of what is permissible in Ghana is relevant. More importantly, the appropriate instruments/documents must be executed when any of the discussed fundraising means are used to offer protection to the entrepreneur, the company and investors.
About the Authors
RICHARD NUNEKPEKU is the Managing Partner of SUSTINERI ATTORNEYS PRUC, a client-centric boutique law firm specialized in transactions, corporate legal services, dispute resolutions, and tax. Richard is also a research and teaching assistant for the Commercial Law Course at the Faculty of Law, Ghana Institute of Management and Public Administration (GIMPA). He is reachable at email@example.com
CECILIA ANTWI KYEM is a Part II student of the Ghana School of Law and interns at SUSTINERI ATTORNEYS PRUC. Cecilia has an interest in Commercial Transactions,Financial Technology (Fintech), Start-ups and SMEs, Company Law and Contracts as well as Alternative Dispute Resolution.