The Structuring section of Winning Angels: the 7 Fundamentals of Early Stage Investing doesn’t go into a lot of detail about planning for future rounds, however, I think this is important enough to dedicate an entire blog post to. The idea of future rounds often escapes rookie entrepreneurs. If a first-time entrepreneur does an initial funding round and gets everything they were asking for, it does not mean that is all the money the business will need. As a company grows, so does its financial needs. Depending on the volume being sold and the margins on each sale, the business may not have enough money to meet demand or make necessary, quick, adjustments to retain their control in the market. That means that the founder will need to do future rounds of funding. The book offers 3 examples of future funding on Interelate (198), Starmedia (199), and Amazon (200).
The key to being able to raise money in future rounds is to keep the deal structure simple. Don’t make investors think too hard about whether or not the deal is worth their time and investment. Let’s take a brief look at two of the examples from the book.
Interlate went through 3 rounds of funding. Initial funding ran in mid-late 1999, and Interlate raised $700K with a pre-money valuation of $2 million (198). In late 1999 to early 2000, a second round of funding raised a total of $4 million with a $10 million pre-money valuation. In early-mid 2000, a third round of funding was completed and raised $25 million with a $62 million post-money valuation. Each round offered stock and pre-emptive rights, however, the final round offered preferred stock options, preferential and liquidation right as well (198).
Starmedia did their first round of funding in January of 1997 and raised $506K with a post money valuation of $5.1 million (199). They offered common stock with this round of funding. Their second round of funding was in April of 1997 and they raised $3.7 million with a post money valuation of $8.9 million (199). This round they offered Series A preferred stock options. Starmedia’s third round of funding came in February of 1998, where they raised $12 million with a post money valuation of $35.6 million (199). They offered Series B preferred stock options with this round. The fourth round of investment was in September 1998 and raised $80 million with a post money valuation of $210 million (199). This round they offered Series C preferred stock options. You see how they kept the deal structure very simple during each round?
The book mentions three rules to follow in planning structure: (1) keep it simple, (2) don’t restrict the company’s ability to do future deals, and (3) make sure the valuation is reasonable (201). Keeping the deal structure simple allows everyone to understand the round’s deal structure and prevent any delays in investment. The only protection from future deals you should consider are ones that protect against value discrimination. Make sure the valuation is reasonable or you limit the amount of funding that future investors (that can ultimately help make the business succeed) who will actually invest in the company.
Amis, David and Howard Stevenson. Winning Angels: the 7 Fundamentals of Early Stage Investing. Pearson Education Limited, 2001.