Corporate Law

Author: Jesse Ahuja & Andrew Hennigar

Unless you’re able to achieve immediate cash-flow, have minimal expenses, or are independently wealthy, at some point your company will need financing. Generally speaking, there are good reasons for a company to issue equity and equally good reasons to issue debt. We’ll save those for another post. Today we’ll review the potential problems with both. For the purposes of today’s discussion, let’s assume your early-stage company is incorporated and organized but is not cash-positive, has no real assets and has exhausted its bootstrapping funds.


A traditional bank loan may be appealing for founders who aren’t willing to give up control by issuing common shares to investors. However, there are a couple of challenges for an early-stage company to obtain a bank loan. Traditional lenders, like banks, need to secure their loans. They do this by using assets (typically equipment or inventory) or cash flow as collateral. Most early-stage companies have no real assets or cash flow against which to collateralize the debt.

The second potential problem is that a traditional loan must be repaid, with interest, according to a schedule. Depending what kind of cash flow your company is generating, you may not be able to satisfy a repayment schedule acceptable to the lender.

Traditional lenders will also impose a number of covenants on your company. For example, you’ll be required to maintain certain minimum financial performance measures. You’ll also be required to provide the lender with regular disclosure of financial and operational information. For most startups, these covenants can be very onerous.


Institutional investors and VCs will want to see customers, product, revenue and a proven management team before they’re ready to inject money into your business. You may not be there just yet.

Assuming you’re able to bring some potential investors to the table – friends, family or angels – issuing common shares is fairly straight forward, provided you have a securities lawyer to navigate the prospectus exemptions and properly paper the transaction. That is, until you get to the purchase price.

You believe your company has meteoric potential value, and presumably your investors are at the table because they share your vision, but calculating that value with an idea but no product, no customers and no proven management team is like throwing darts in the dark. Despite the “unicorn” valuations you’ve seen in the media, those are outliers and it’s often too early for a meaningful valuation.

Let’s say you’re willing to sell 10% of your company for $1M. That means a $10M valuation which, at this stage in your company’s life, will almost certainly be rejected by any savvy investor. Even if your investors are willing to participate at that rate, it may not be a good idea. Closing a seed round with a high valuation might seem like a big “win” but it sets the water mark for the company’s fair market value. Any future raise at a lower valuation (called a “downround”) may reflect poorly on management and perception of the company’s progress. Any subsequent option grants to employees would need to be at the new valuation or be a taxable event for the recipient.

So how do startups mitigate the problems associated with issuing straight equity or debt? Stay tuned for Part 2 of this post coming next week.

Interested in hearing more? Don’t miss our upcoming webinar, Show Me the Money: Corporate Finance for Early/Growth Stage Companies, jointly presented with Boast Capital from 11:00am – 12: 00pm PST on February 25, 2016, or contact MEP Business Counsel at 604-669-1119. To participate in the webinar REGISTER HERE.

This post is for informational purposes only and does not constitute legal advice or an opinion on any issue. If you are interested in receiving additional details on the topic above or advice about specific circumstances, please contact MEP Business Counsel at 604-669-1119.