Founder series: What should I know about priced equity rounds? November 15, 2022

Many start-ups use direct investments to raise capital, in particular, share subscriptions in priced equity rounds  

MDW’s Founder Series has previously explored Convertible Notes and SAFE Notes as methods to raise funds for early-stage companies, start-ups or companies wishing to expand their operations. This article explores the use of direct investments to raise capital, particularly by share subscriptions in a priced equity round.

How does a priced equity round work?

In a priced equity round, a company undertakes capital raising where a valuation is agreed upon, with a fixed price per share, and shares are issued upfront to investors.

However, there are advantages and disadvantages to direct investments. 

A priced round might appeal to investors because they get shares upfront at a fixed price based on the company valuation at the time of investment. Similarly, founders have certainty of investment. However, this is often at the cost of sacrificing some control early on. In other words, dilution. 

It’s because shares are issued to investors immediately. On the other hand, the amounts invested in convertible notes and SAFE notes convert to equity later. It’s also why it’s more common for established start-ups to use priced equity rounds.

This fundraising method may also be preferable for founders who have a clear idea of their company’s value and growth potential and are willing to issue shares at this early stage. It is a particular consideration because issuing shares can dilute decision-making control.

Sound simple? Hardly. As we discussed in our previous articles, negotiating the value of a company and the associated transaction documents can be complex, time-consuming and expensive.

What’s involved in offering a priced equity round? 

1. Negotiations: There will be many terms to negotiate with investors, including preferential rights, investment amounts, and pre and post-money valuations.
2. Term Sheet: This sets out the key commercial terms between the parties, which will form the basis of the later longer form agreements. It is important to use a term sheet early on to record what the parties have agreed. It will save time and cost in drafting the final legal agreements later.
3. Share Subscription Agreement: This agreement is based on the Term Sheet and sets out the company and the investor’s responsibilities to issue the shares and complete the investment. For example, it will include the number of shares to be issued and any conditions to meet before the company issues the shares.
4. Shareholders Agreement: Once the company has issued capital, it may enter into a shareholders agreement with the shareholders. These agreements often include voting rights and procedures for company meetings, processes for exiting the company and, importantly, certain ‘founder shareholder rights.’

Given the above, it is clear why priced equity rounds are often the more time-consuming and expensive option. However, they also provide certainty to both founders and investors. There is no preferred option for raising capital, and the most desirable method will depend on several factors, including:

• The circumstances, goals and preferences of the founders
• The need for capital
• Market conditions
• Investor interest and confidence

Other ways to raise capital

Our previous Founder Series articles have explored other ways to raise capital, namely convertible notes and SAFE notes.

Convertible Notes

• Convertible notes represent a debt that often attracts interest
• They include a maturity date at which the debt must be repaid
• The company valuation is postponed 

SAFE Notes

• SAFE notes are not a debt instrument  
• Investors advance the company money in exchange for a promise of shares at a future date
• Usually, the only terms to negotiate are discounts and valuation caps
• The company receives money straight away in return for promising to issue stocks later
• The company valuation is postponed

In contrast to convertible notes and SAFE notes, priced equity rounds have the following features:

• Company valuation is set
• Shares issued upfront
• SAFE notes convert, and new investors invest
• They require more negotiation and documentation

The final word

If you’re considering using a direct investment strategy to raise capital for your company, a priced equity round may be worth considering. Although they can be more complex than other capital-raising avenues, the advantages may be significant in the right circumstances. 

Our corporate team assists many companies, including start-ups, with capital-raising activities. Contact us to learn more about our services and how we can help your business with a priced equity round. 

By Milly Berry

Lawyer – Commercial & Property team

DISCLAIMER: We accept no responsibility for any action taken after reading this article. It is intended as a guide only and is not a substitute for the expert legal advice you can receive from marshalls+dent+wilmoth and other relevant experts.