Raising capital is a common strategy used by private companies to scale their operations, develop new products, and strengthen their market position. In Australia, private companies have several avenues through which they can secure additional funding, each with unique benefits and challenges. This article focuses on equity capital raising in Australia, in particular:

• What is equity financing?
• Who invests in equity financing rounds?
• What are the key legal documents required to undertake an equity financing round?
• What are the key benefits and limitations of equity financing?

What Is Equity Financing?

Equity financing involves raising capital through the issuance of new shares. Put simply, the company agrees to issue, and the investor agrees to buy, shares in the capital of the company at an agreed price and on agreed terms. The capital injected by the investor can then be used by the company to fuel growth and satisfy the working capital needs of the business.

Who Invests In Equity Financing Rounds?

Private companies, unlike public companies, cannot list and sell shares on a public stock exchange, such as the ASX. This means an offer of shares by a private company to an investor must be personal in nature and cannot be made to the public at large. Investors in private companies are commonly made up of one or more of the following:

• Private Individuals – often high-net-worth individuals and angel investors. These investors can provide financial backing, industry expertise, and strategic relationships within their networks. As a starting point, many early-stage ventures receive investment from friends and family. Receiving investment from friends and family can be a viable way to secure funding initially, but it can complicate personal relationships and deter prospective investors in certain circumstances (for example, where the company has a high volume of investors comprised of friends and family who did not invest on an arms-length basis).
• Venture Capital (VC) Funds – often invest in high-growth start-ups and early-stage companies with strong prospects and scalable business models. VCs are sophisticated investors who typically invest funds contributed by a number of underlying investors (known as ‘limited partners’), and for this reason, they are generally able to invest larger sums of money than private individuals. Aside from capital, VCs can provide invaluable guidance and strategic know-how to founders. Investing in early-stage companies is risky, but the return on investment can be equally, if not more, impressive.
• Private Equity (PE) Firms – often invest in established, mature businesses requiring capital for expansion, acquisitions, and restructuring. PE firms generally invest large sums of capital in exchange for a substantial ownership interest (in many cases, greater than 50% of the company’s share capital). PE firms generally play an active role in the management and operation of the business, particularly when acquiring a controlling interest in the business.

What Are The Key Legal Documents In An Equity Financing Transaction?

Companies and investors should always enter into binding legal documents in connection with an equity financing transaction, irrespective of the profile of the parties or the size of the investment. This ensures the rights and obligations of all parties are clear from the outset.

Core Transaction Documents

• Subscription Agreement – the Subscription Agreement is a document under which the investor agrees to purchase, and the company agrees to issue, shares in the company at an agreed price. The Subscription Agreement sets out, among other things: the number and class of shares issuable to the investor; the price payable per share; the parties’ obligations with respect to the investment; the conditions, if any, which must be satisfied prior to and following completion; and the warranties and representations given by the parties.
• Constitution – The Constitution sets out the rules applicable to the company’s governance and operations, including: the rights and responsibilities of shareholders and directors; the procedures applicable to shareholder and board meetings; voting and dividend entitlements; and the rights attaching to specific share classes issued by the company, for example, liquidation preferences and anti-dilution rights in the case of preference shares.
• Shareholders Agreement – the Shareholders Agreement sets out the relationship between the company, its shareholders, and founders. This document is generally substantive and may covers, among other things:
  • how the company is managed, including the types of decisions requiring approval by the company’s board of directors and those which require the approval of shareholders;
  • whether certain shareholders are entitled to appoint a director or observer to the company’s board;
  • whether certain shareholders hold their equity subject to restrictions, such as vesting arrangements, lockups, and restraint of trade provisions;
  • the processes applicable in relation to certain transactions such as share issuances, transfers, and exits, and any rights which may arise in those contexts, for example, pre-emptive rights, ‘drag along’ and ‘tag along’ rights;
  • rights and obligations with respect to intellectual property and confidential information.
• Disclosure Document – as a rule of thumb and unless an exception applies, companies raising capital must provide investors with a disclosure document in the form prescribed by the Corporations Act 2001 (Cth) (Corporations Act) setting out critical information in relation to the company, the investment, and any risks associated with the investment. The type of disclosure document required, if any, varies on a case-by-case basis depending on the nature of the transaction.

Ancillary Documents and Steps

Companies and investors must also consider the following ancillary documents and steps, in addition to the core transaction documents listed above:

• Board and Shareholder Approvals – the company may need to obtain approvals and/or waivers from its board of directors and shareholders in relation to the proposed transaction.
  The types of approvals required and the processes to be followed will depend on the nature and structure of the proposed transaction, the terms of the company’s existing corporate governance documents (if any), and the requirements under the Corporations Act.
• Pro-forma Capitalisation Table – a company’s cap table calculates the price per share issuable as part of the funding round and the number of shares issuable to each investor participating in the raise. The cap table also provides a detailed breakdown of the company’s share capital before and after the raise, including any reservation for employee share option or similar incentive schemes.
• IP Assignment Deed – investors may require founders and key stakeholders to enter an IP Assignment Deed in favour of the company, ensuring that any intellectual property critical to the business is retained by the company even if key personnel leave.
• Deed of Access, Insurance, and Indemnity – if an investor negotiates the right to appoint a director to the company’s board, they may require a Deed of Access, Insurance, and Indemnity to protect their appointed director. As the name suggests, this documents sets out the director’s right to access certain information, the company’s obligation to take out and maintain specific insurances and provide indemnities to cover the director for certain liabilities.
• Share Certificates – issued as evidence of ownership of shares in the company, detailing the number and class of shares held by the recipient.
• Members’ Register – section 169 of the Corporations Act requires the company to maintain a register recording shareholder details and share transactions. The company will need to update its Members’ Register to reflect new share issuances.
• ASIC Notification – companies must notify the Australian Securities and Investments Commission (ASIC) of certain changes and transactions, such as the issue of new shares, typically within 28 days following completion of the raise.

Key Benefits and Limitations of Equity Financing

Benefits

• Provides access to capital to fuel growth and expansion.
• Strategic investors may provide industry expertise, access to valuable connections, guidance, and mentorship.
• Unlike debt funding, equity investments do not require repayment, making it a less risky and financially onerous option.
• Investors do not take collateral or security over the company’s assets.
• Generally straightforward, cost-effective, and faster than other funding methods.

Limitations

• The ownership stake of existing shareholders will be diluted unless increased as part of the funding round.
• Valuing companies is notoriously difficult, particularly early-stage and pre-revenue ventures.
• Incoming investors, especially sophisticated and professional investors, often expect certain rights that may reduce founder control.
• New investors may have different visions for the company, potentially leading to strategic and operational disagreements.
• While generally efficient, negotiations can become protracted and costly if there are many investors with competing interests.

Contact Us

Contact our experienced corporate transactional lawyers on 03 9481 2000 or info@tauruslawyers.com.au to discuss how we can help your company plan for, and execute, its equity funding round.