Equity funding is the most common method for financing a startup business. Companies generally have 2 types of stocks: common and preferred stocks.
Problem
First-time founders often make common errors raising funds in the early stage. Here are some common errors:
1. First time entrepreneurs sometimes make the error of using common shares for investors during early stage.
2. Selling preferred shares with very low company valuation during early stage
These fund raising errors cause substantial problems for the company to raise funds at a later date. Later professional investors may require the company to void all stock agreements in place and demand the company to redo the
stock plan creating huge problems with existing stock shareholders.
Solution
Startups should use this popular funding strategy to grow the company:
1. Common stock shares should be used for all non-investors; including founders, employees, consultants, etc.
2. Preferred shares should not be issued for early stage funding
3. Early stage funding should use “Convertible Note” with interest and discounts for later conversion to preferred shares.
4. Preferred shares should be issued when significant investment occurs with reasonable market valuation of the company
