The Cap Raise: Governance

The Cap Raise: Exploring the Nuance between Venture Capital and Broker-dealers


Post-investment, most investors who lead an investment round, and particularly institutional investors, want some governance rights or “control” over the future decisions made by the company.  On the light end of the spectrum, this might include one vote per one share common stock voting rights for “major” decisions such as the sale of the company.  On the heavier end of the spectrum governance might include board seats, veto rights on certain matters, or rights to affirm certain executive hires, etc.

Both venture capital firms (VCs) and broker-dealers (BDs) will help you raise capital as either equity or debt. The majority of VC transactions are for equity. VCs will more often focus debt raises as convertible debt: their investment will accrue interest until a predetermined event, at which time it will be converted into equity, often at a premium. If that event–which is most often another capital raise or liquidation event–doesn’t come, the VC is entitled to their full investment plus accrued interest. BDs can help you raise a variety of debt or equity structures. Fundamentally, selling equity will sell more control than selling debt. So, if you’re already bristling at the idea of selling control, you likely aren’t a suitable candidate for a VC.

With a broker-dealer, a licensed investment banker will work with you to set appropriate terms for the investment based on a target investor profile. Bankers will sell your security for you, using their network of investors and other outreach strategies. Bankers are generally paid in large part, and sometimes exclusively, based upon success. It is in their interest from a revenue perspective, as well as from a compliance perspective as a FINRA-regulated body, to price the offering appropriately. Fees are proportional to what they bring to the table (often not the entire raise, if selling duties are shared or the company has previous investor relationships). You provide bankers with compensation and full disclosure, but you do not owe the bankers or broker-dealer equity, control, or warrants (although all of these are possible). Now, before you get too excited, you do owe your equity investors shares in your business. Your specific term sheet will determine what control you provide to investors for issues such as liquidation preference and decision-making. Just because you can offer limited control doesn’t mean investors will accept it. A common occurrence for BD offerings is to provide investors with dividends as well as upside equity appreciation.

VCs will often require more control, but they also provide more in return. As business partners, round-leading VCs will often make valuable professional introductions, offer sage advice on business matters and help recruit valuable team members. Their board seat, depending on the firm and the fit, can often be much more of a blessing than a curse. Experienced VCs will be able to assist entrepreneurs with analyzing financial projections, marketing campaigns, sales strategies and operational challenges. And, perhaps most importantly, VCs often have a network of other investors to follow along.

VCs generally will negotiate for investment terms that safeguard their investors in the case of abrupt liquidation, as well as significant upside upon success. It is not uncommon for VCs to expect the full value of their investment (sometimes 2 to 3x that initial investment) in case of liquidation–after debt is paid off but before any return is provided to common shareholders. Venture capital firms typically invest in a wide variety of startups, knowing many of them will fail. The infusion of capital, and the influence of the board seat, generally prods company management to scale quickly. If a business does not live up to expected revenue or profitability growth, subsequent capital rounds will be unlikely to materialize.

In summary, depending on the expected scale and scope of your business, you may need investment from a VC to raise large amounts of capital, and giving up some control at that stage is neither solely negative nor solely positive. If your company is raising capital through a BD, you will be able to set your own terms, but those terms will affect whether your offering is salable, and to whom. In fact, your financials will be more highly scrutinized–often requiring audit–to prove your point. If your business is set up to accept outside audit, due diligence, and is attractive enough to sell to potential investors, then using a broker-dealer may be an important consideration. In time, more growth stage companies may take advantage of disruptive broker-dealers that reduce the costs of raising capital compared to legacy model investment banks, and companies may often consider and compare BDs with VCs before initiating a capital raise.