To raise capital to start a business legally, you form a recognized business entity, build the financial and governance documents that funders require, and then choose among four main paths: bank or SBA loans, equity from angel investors or venture capital, crowdfunding, or government grants. Each path has its own paperwork, legal rules, and trade-offs, and the choice shapes your taxes, your ownership, and your personal exposure if things go wrong. Most founders begin with personal savings, but scaling past that point means stepping into one of these funding structures, and skipping the setup work can disqualify you before a single conversation starts.
Set Up the Entity Before You Ask Anyone for Money
No lender or investor will write a check to a person running a side project. The business has to exist as a legal entity. That means filing formation documents with your state’s Secretary of State: Articles of Incorporation for a corporation, Articles of Organization for an LLC. Filing fees range from under $50 to $500 depending on the state and entity type.
The entity type you choose matters for fundraising. A C-Corporation is the standard structure for companies seeking venture capital because it allows multiple classes of stock with different rights. An LLC works well for smaller operations and bank-financed businesses but can create complications when issuing equity to outside investors. If outside investors are in your plans, talk to a business attorney about entity selection before you file anything.
After formation, you need an Employer Identification Number (EIN) from the IRS, obtained by filing Form SS-4.1Internal Revenue Service. About Form SS-4, Application for Employer Identification Number (EIN) Every bank, lender, and investor will ask for it. The application is free and can be completed online in minutes.
You also need internal governance documents: an operating agreement for an LLC, bylaws for a corporation. These spell out who owns what, how decisions get made, and how profits are divided. Investors and lenders review them closely. Not having them signals that the business isn’t being run as a real entity separate from its founders, and that distinction matters for personal liability protection too.
Build the Document Package Funders Will Ask For
Whether the money comes from a bank, an angel, or a grant committee, the core request is the same: projected financials and a business plan.
Financial projections should cover three to five years and include three documents:
- An income statement (profit and loss) showing anticipated revenue minus expenses, and when the business becomes profitable.
- A cash flow statement mapping the timing of money in and out, proving the business can pay its bills during slow months.
- A balance sheet listing what the company owns against what it owes, giving a snapshot of net worth at a point in time.
Ground the numbers in real industry data. Projecting 40 percent margins in a 12-percent-margin industry without a strong explanation ends the conversation on page one.
The business plan ties it together: executive summary, market analysis with real data on demand, and a marketing and sales strategy that names what customer acquisition actually costs. Keep it concise. The plans that survive the first scan are the ones that get to the point.
Capitalization Table
If you plan to raise equity, start a cap table on day one. It tracks every owner, the type of equity they hold (common stock, preferred stock, options, convertible notes), ownership percentages, and the price per share at each funding round. Investors scrutinize it during due diligence, and errors can delay or kill a deal.
Your Personal Financial Package
For a startup with no operating history, your personal finances are part of the review. Pull your credit reports before you apply for anything. A personal credit score below 680 can make traditional bank and SBA loans difficult, though some alternative lenders work with lower scores at higher rates.
Prepare a personal financial statement listing assets (real estate, investment accounts, vehicles) and liabilities (mortgages, student loans, credit card balances). Expect to provide at least three years of personal tax returns, including Form 1040 and, if you’ve had self-employment income, Schedule C.2Internal Revenue Service. About Schedule C (Form 1040) If the business has operated in any form, its returns will be requested too. The goal is to verify that what you reported to the IRS matches what you’re telling the lender.
Start building a business credit profile early. Trade accounts and business credit cards in the company’s name establish a track record. Business credit scores like the Dun & Bradstreet PAYDEX run 1 to 100 and reflect how promptly you pay vendors. A strong business credit history reduces your dependence on personal guarantees over time.
SBA and Bank Loans
The Small Business Administration doesn’t lend money directly. It guarantees a portion of loans made by participating banks and credit unions, which reduces the lender’s risk and makes them more willing to fund startups and small businesses.3U.S. Small Business Administration. 7(a) Loans You apply through the lender, not through the SBA.
The 7(a) Loan Program
The 7(a) program is the SBA’s most widely used loan program, with a maximum loan amount of $5 million.3U.S. Small Business Administration. 7(a) Loans The SBA guarantees up to 85 percent of loans of $150,000 or less and 75 percent of loans above that amount. That guarantee protects the bank, not you.
Interest rates are capped at a set spread above the prime rate, with smaller loans allowed a higher spread. The SBA also charges a guarantee fee based on loan amount and maturity, which lenders typically pass through to the borrower. Some lenders have Preferred Lender Program (PLP) status, meaning they can approve and close SBA loans without routing each application to the SBA for individual review, which speeds the timeline considerably.4U.S. Small Business Administration. Types of 7(a) Loans
The 504 Loan Program
The 504 program is for purchasing major fixed assets like commercial real estate or heavy equipment. A conventional lender covers about 50 percent, a Certified Development Company covers up to 40 percent with an SBA-backed debenture, and you put down at least 10 percent. If you need working capital rather than real estate, 7(a) is the right program.
Closing and the Personal Guarantee
At closing you sign a promissory note and a security agreement giving the lender a lien on business assets. The lender files a UCC-1 financing statement to put the lien on public record, which notifies other creditors that the bank has first claim on those assets if you default.
SBA loans almost always require a personal guarantee from any owner holding 20 percent or more. If the company fails, the bank can come after your personal assets. The corporate liability shield does not protect you from a debt you’ve personally guaranteed. Read guarantee language before you sign it, not after.
Angel Investors and Venture Capital
Equity financing means selling ownership in your company in exchange for cash. Angel investors are typically wealthy individuals investing their own money in early-stage companies. Venture capital firms pool money from institutional investors like pension funds and endowments, then deploy it into startups in exchange for preferred stock with special rights. In both cases you get capital without taking on debt, but you give up a percentage of ownership and, usually, some control.
The Term Sheet
If an investor is interested, they issue a term sheet. It’s a non-binding outline of the proposed deal: valuation, ownership percentage, voting rights, board seats, and liquidation preferences. Liquidation preferences determine who gets paid first if the company is sold or shut down, and they can dramatically affect what founders actually receive in an exit.
Two provisions deserve close reading. An anti-dilution clause protects the investor if the company later raises money at a lower valuation. Under a full ratchet provision, the investor’s conversion price drops to match the lower price, which can devastate a founder’s ownership percentage. Weighted average anti-dilution is more common and less punishing because it accounts for how many new shares were issued at the lower price relative to total shares outstanding. Know which type you’re being offered.
A right of first refusal (ROFR) gives existing investors the option to match any third-party offer before a shareholder can sell shares to an outsider. The selling shareholder must notify the ROFR holder of the terms, and the holder typically has 15 to 30 days to decide whether to match. If they decline, the sale proceeds.
Due Diligence and Closing
After the term sheet, the investor’s lawyers and accountants examine every contract, employment agreement, intellectual property filing, and financial record. Discrepancies can lead to a renegotiated valuation or a withdrawn offer. Sloppy record-keeping from the early days comes back to bite you here.
Once diligence clears, counsel drafts the definitive agreements. For a priced equity round, that’s a Stock Purchase Agreement. For earlier-stage deals, it’s often a Convertible Note or a SAFE (Simple Agreement for Future Equity). The company issues shares, updates the cap table, and the capital lands in the corporate treasury.
Securities Rules When You Sell Equity
Selling ownership in your company means selling securities, and federal and state securities laws apply. Most startups rely on exemptions from full SEC registration, but those exemptions carry their own rules.
The most common exemption is Regulation D, specifically Rule 506. Under Rule 506(b), you can raise an unlimited amount from accredited investors without public advertising. Under Rule 506(c), you can advertise publicly but must verify that every investor meets the accredited investor thresholds: individual income above $200,000 (or $300,000 joint with a spouse) in each of the two most recent years with a reasonable expectation of the same in the current year, or a net worth exceeding $1 million excluding the primary residence.5eCFR. Regulation D – Rules Governing the Limited Offer and Sale of Securities Without Registration Under the Securities Act of 1933
After the first sale of securities in a Regulation D offering, you must file a Form D notice with the SEC within 15 calendar days. There is no filing fee.6U.S. Securities and Exchange Commission. Filing a Form D Notice Missing the deadline doesn’t void the exemption on its own, but it can trigger SEC scrutiny and complicate future fundraising.
Federal law preempts state-level registration for Rule 506 offerings, but most states still require a notice filing and a fee after you sell securities to their residents. Ignoring these requirements can produce fines or enforcement actions. A securities attorney should handle these filings as part of closing.
Crowdfunding
Crowdfunding comes in two fundamentally different flavors, and the legal requirements are worlds apart.
Reward-Based Crowdfunding
Platforms like Kickstarter and Indiegogo let you raise money in exchange for a product, perk, or thank-you. Backers are not buying ownership, so securities laws don’t apply. Setup requires identity verification and linked bank account details, but there’s no SEC paperwork. These campaigns work best for consumer products with visual appeal. A B2B software company is unlikely to find its audience here.
Equity Crowdfunding Under Regulation CF
Regulation Crowdfunding, created by Title III of the JOBS Act, lets companies sell actual securities to the general public through SEC-registered platforms.7U.S. Securities and Exchange Commission. Regulation Crowdfunding The maximum you can raise under Reg CF is $5 million in a rolling 12-month period.8U.S. Securities and Exchange Commission. Regulation Crowdfunding Compliance and Disclosure Interpretations
The paperwork is real. You file a Form C with the SEC disclosing financial information, officer and director details, the intended use of proceeds, and the terms of the securities being offered.7U.S. Securities and Exchange Commission. Regulation Crowdfunding The financial statements required scale with how much you’re raising. Smaller offerings may only need tax returns reviewed by an independent accountant; larger ones require audited financials.
Individual investors also face limits on how much they can invest across all Reg CF offerings in a 12-month period, based on their income and net worth. After the campaign closes and the target is met, expect a waiting period before the platform releases funds.
Government Grants
Grants don’t require repayment and don’t dilute ownership, which makes them the most attractive capital on paper. In practice, they’re competitive, slow, and restrictive.
Federal grants are posted and managed through Grants.gov. Before you can apply, you need to register in the System for Award Management (SAM) at SAM.gov, which assigns you a Unique Entity Identifier (UEI).9SAM.gov. Entity Registration Registration is free but can take several weeks due to manual verification. Start well before any application deadline. Without an active SAM registration, you cannot apply for federal awards.
Each opportunity is governed by a Notice of Funding Opportunity (NOFO) that spells out eligibility, scoring, and reporting obligations. Proposals go through a technical evaluation panel, and the timeline from submission to award notification often runs six months to a year. If selected, you receive a Notice of Award (NOA) that serves as the binding agreement and dictates how and when you report on expenditures.
What You Cannot Spend Grant Money On
Federal grants are governed by the Uniform Guidance cost principles, which prohibit spending on items that would be routine business expenses if paid with your own money. Unallowable costs include alcohol, entertainment, fundraising activities, lobbying, country club memberships, and personal-use goods or services for employees.10eCFR. Subpart E Cost Principles Even interest on borrowed capital is generally unallowable. Spending grant funds on prohibited items can trigger repayment demands and disqualification from future awards.
Tax Implications of Debt Versus Equity
The type of capital you raise has direct tax consequences.
Interest payments on loans are generally deductible as a business expense, which lowers taxable income. The deduction isn’t unlimited. Under Section 163(j) of the Internal Revenue Code, business interest expense deductions are generally capped at 30 percent of the company’s adjusted taxable income, plus its business interest income and any floor plan financing interest.11Internal Revenue Service. Questions and Answers About the Limitation on the Deduction for Business Interest Expense For most startups, this cap rarely bites because interest payments are small relative to other expenses. The loan proceeds themselves are not taxable income, because the money you received is offset by an equal obligation to repay it.
Money received from selling stock is also not taxable income to the company. It’s a balance-sheet transaction, not revenue. But if the company is a C-Corporation, future profits face double taxation: the corporation pays tax on earnings, and shareholders pay tax again when those earnings are distributed as dividends. Dividends are not deductible to the corporation, unlike interest on debt. For pass-through entities like S-Corporations and LLCs, the calculus differs because income flows through to the owners’ personal returns rather than being taxed at the entity level. Model both structures with an accountant before locking in a funding strategy.
Keep the Liability Shield Intact
Forming an LLC or corporation creates a legal wall between business debts and your personal assets. The wall only holds if you treat the company as a genuinely separate entity. Courts can “pierce the corporate veil” and hold you personally responsible for company debts when the business is really just your alter ego.
The behaviors that get founders into trouble are common:
- Commingling funds. Paying personal bills from the business account, depositing business checks into your personal account, or covering your mortgage with a company check.
- Skipping formalities. Never drafting an operating agreement, failing to hold required annual meetings, or using your own name interchangeably with the company’s on contracts and invoices.
- Undercapitalizing the business. Starting with so little money that the company clearly can never meet its obligations, which courts may read as evidence the entity was a sham.
Personal guarantees bypass the corporate shield entirely by design. When you sign a personal guarantee on an SBA loan or a commercial lease, you’re voluntarily agreeing the lender can pursue your personal assets if the business can’t pay. Most SBA loans require personal guarantees from owners with 20 percent or more ownership. A personal guarantee turns a business debt into a personal one, regardless of how carefully you maintain the corporate veil.
The protection itself is boring and effective: keep separate bank accounts, document major decisions in writing, maintain your governance records, and never treat the company’s money as your own. If the business is properly capitalized and run as a distinct entity, the shield generally holds.