For cash-strapped founders building early-stage and high-growth ventures, raising capital is often essential for getting off the ground and fuelling growth. Companies can raise capital through equity (selling ownership stakes) or debt (borrowing money). While traditional businesses often use both, startups rarely touch conventional debt financing because they lack the cash flow to service debt payments. Even when they achieve profitability, founders typically want to reinvest every dollar back into growth.

This reality shapes the startup financing landscape. While specialized venture debt lenders exist for later-stage companies, early-stage founders primarily rely on equity financing. Below is a high-level summary of the framework of startup fundraising, ranging from early-stage financings to institutional rounds.

The fundamental challenge in pre-seed and seed stage investing is valuation. How do you price shares in an early-stage company which may not have any revenue or traction? Rather than forcing an arbitrary valuation, the market has developed elegant solutions that allow investors to put money in now while delaying the valuation discussion until the company matures.

Convertible notes are essentially loans that convert into equity during the next priced round (a “qualified financing”). Instead of being repaid in cash, the amount owing under the note converts into shares based on the issue price in the qualified financing. To compensate early investors for their risk, these notes typically include two sweeteners: a discount on the qualified financing issue price (typically 10-20%, with exceptions) and a valuation cap that sets a ceiling on the conversion price regardless of how high the company's valuation soars.

SAFEs function like convertible notes where the subscription amount is converted into shares upon a qualified financing, but without interest accrual or a maturity date. While convertible notes are not typically expected to be repaid in cash, the SAFE eliminates the theoretical risk of the company having to repay the loan. Investor preferences between convertible notes and SAFEs vary, often reflecting regional market norms and individual investor sophistication.

These early rounds typically involve friends, family and angel investors writing smaller cheques. While there is a robust infrastructure of pre-seed institutional investors south of the border, British Columbia's venture ecosystem typically sees funds entering at later stages where they can deploy larger amounts of capital and justify cross-border investments.

Once a company demonstrates traction (typically by seed or Series A stage), institutional venture capital enters the picture. The centrepiece of institutional rounds is the preferred share, a security class that sits above common shares in the liquidation hierarchy, which means that upon a sale or liquidation of the company, preferred shareholders get paid before common shareholders. This protects downside risk for investors writing larger cheques.

In institutional rounds, through shareholders’ agreements and updated share rights, preferred shares are loaded with negotiated rights including liquidation preferences, anti-dilution protection, board seats, veto rights over major decisions, and information rights. Expect weeks of negotiation as investors seek control rights and economic protections commensurate with their investment size.

Institutional investors typically require more robust corporate governance to be implemented, including board representation by the investor or its nominees, regular board meetings and financial reporting packages. In addition to the changes arising from raising substantial capital, expect more formal governance structures and investor oversight going forward.

Every capital raise, whether involving shares, convertible notes or SAFEs, triggers securities law requirements. In Canada, this means ensuring all investors qualify under prospectus exemptions. Companies must maintain detailed documentation outlining each investor's representation as to his, her or its applicable prospectus exemption.

For private issuers (most early-stage companies), securities can only be sold to specific categories such as family members, close friends, business associates and accredited investors. Accredited investors qualify based on financial thresholds, including, for example individuals with $1 million in net financial assets (excluding primary residence) or annual income exceeding $200,000 ($300,000 including spouse).

The progression from convertible instruments to priced equity rounds reflects the natural evolution of startup risk and valuation certainty. Early-stage founders will often find themselves raising capital through SAFEs or convertible notes to close funding quickly without lengthy negotiations. As your company matures and attracts institutional capital, expect increased complexity but also more sophisticated partners who can provide strategic value beyond capital.

The startup financing ecosystem has evolved these structures over decades to balance founder control with investor protection. Understanding these dynamics helps founders navigate fundraising more effectively, whether closing their first SAFE or negotiating their Series A.

Remember that each financing round sets precedents for the next. Terms accepted today become the baseline for tomorrow's negotiations. It is recommended that you seek legal advice from an experienced startup lawyer in connection with the structuring, negotiation and execution of capital raising transactions.