For start-ups, securing investment is just as crucial as coming up with an idea and developing a product or service. Start-ups naturally require investment to bring a project to life and foster its growth.
In this article, we will briefly explain the financing methods that start-ups can use to secure investment. Nowadays, the following models are commonly preferred for start-ups to access financing from investors:
- Raising capital through equity injection
(“Capital Increase”),
- Raising financing through convertible loan/bond
(“Convertible Loan/Bond”),
- Financing through equity-like investment instruments such as
Simple Agreement for Future Equity
(“SAFE“), Advanced Subscription
Agreement (“ASA“), Keep it Simple
Security (“KISS“), Easy Prepayment on
Shares (“EPOS“), commonly used in
countries like the United States, the United Kingdom, and the
Netherlands (“Equity-like Investment
Instruments“) and
- Raising financing through crowdfunding (“Crowdfunding“).
Start-up investors typically consist of angel investors (investors in the pre-seed and seed stages), venture capital funds (“VC“), and as start-ups grow, private equity and strategic investors also come into play in later stages (Series A, Series B, etc.).
Capital Increase
When seeking investment through the Capital Increase, investors contribute the investment amount as a cash injection to the startup. Pursuant to the Turkish Commercial Code, start-ups can raise capital either as Capital Increase at the nominal value or as a Capital Increase with a share premium. Following the capital amount is invested, start-ups issue new shares to investor(s), and investor(s) become shareholders in the start-up.
On the other hand, Capital Increase results in dilution of the ownership stake of the founders. In other words, since the company is issuing new shares, total number of shares increases, and in turn, the shareholding percentage of existing shareholders (founders) decreases. To reduce this dilution effect, Capital Increases are conducted with share premium that reflects the true valuation of the company's shares, rather than at the nominal value of the company's shares.
To illustrate this with an example, let's assume a company has a total nominal capital of TRY 100,000, however, its valuation is TRY 100,000,000. In this case, for each new share with a nominal value of TRY 1 issued during the Capital Increase, an expected payment of TRY 1,000 as an investment is required to reflect the valuation of the company. To achieve this, the Capital Increase is conducted with share premium, and the amount exceeding the nominal value, TRY 999, is considered share premium. The share premium amounts injected into the company are considered as legal reserve and can be freely used in the company's operations.
Convertible Loan / Bond
Start-ups can access financing not only through direct equity investment, but also through debt financing instruments. However, startups generally opt for convertible debt financing options, which are more favorable compared to high-interest bank loans with onerous terms. This method generally appears as Convertible Loan, a type of loan, or Convertible Bond, a capital market instrument.
In a Convertible Loan transaction, the investor provides financing to the start-up with a loan which can be converted into the start-up's shares under certain conditions. According to the terms of the loan, the start-up can either repay the loan and interest accrued under specific conditions, or instead of repaying the loan amount, issue shares to the investor through a Capital Increase.
In a Convertible Bond transaction, the investor provides financing to the start-up by purchasing a convertible bond issued by the start-up. Additionally, if a bond is issued by a company established in Türkiye to be sold to investors residing in Turkey, issuance and sale of such bond are regulated under the Capital Markets Board. Start-ups can either make principal and interest payments to investors on the repayment date or issue shares to investors through a Capital Increase, as specified in the terms of the bond issuance documents.
Through these two methods, start-ups can access financing without conducting a Capital Increase initially, allowing them to quickly secure funds without going through the procedures of a Capital Increase outlined in the Turkish Commercial Code. However, unlike a Capital Increase, considering financing is provided through debt instruments by investors, investors have the option to demand repayment of the financing under the agreed terms.
Equity-like Investment Instruments
In SAFE, ASA, KISS and EPOS and similar structures, investors can convert their investments into shares at a relatively lower valuation in a future investment round or after a certain period of time. The key mechanism here is that the investors provide early-stage funding to the start-up through Equity-like Investment Instruments, allowing them to become shareholders in the start-up on more favorable terms in later stages.
These instruments are generally considered Equity-like Investment Instruments; however, in certain cases, investors may include repayment provisions related to the investment amount to make these investments similar to Convertible Loans.
Crowdfunding
Crowdfunding is an emerging alternative method to traditional start-up investment financing. Financing for a project or a product/service is typically provided through small contributions by a large group of people, often via online platforms.
In Turkey, Crowdfunding has become one of the frequently used financing methods and can be conducted as donation-based, reward-based, debt-based, or equity-based Crowdfunding; however, equity-based Crowdfunding has been predominant in recent times.
The content of this article is intended to provide a general guide to the subject matter. Specialist advice should be sought about your specific circumstances.