For the past 2 decades I have enjoyed being a part of many interesting companies in
many different industries. For the
past decade my attention has been focused on starting companies and helping
other entrepreneurs start or grow their companies. Every so often I am fortunate enough to see a company grow and eventually go public or get acquired.
One
thing that always amazes me is when companies raise capital they don’t often realize
the impact that the financing will have on a liquidity event. Often when closing a round the team is
just focused on getting the money into the company regardless of cost or
financing terms (trust me I have been there and done that). One piece of advice I give to companies
in the fund raising process is to make sure they waterfall out the financing
and run scenario analysis on exit levels.
It may seem premature to look that far out and you may not have the
ability to change the terms but it will set expectations with the team and ensure
that all parties are aligned (investors and founders). If all parties aren’t aligned it
will just create tension down the road when one side wants to exit while the
other wants to continue building value as the economic incentive may not there
at the current levels.
When
closing a round it is easy to focus on pre-money and post-money valuations and
your relative ownership percentage without really understanding the waterfall
in a liquidity event. As a founder
it is easy to think that this will be the only round you raise and that in two
years the company will be sold or go public at a valuation with eight zeros
behind the first number. Well
history tells us that won’t be the case.
You need to assume you will raise another round (or more) and that the
exit valuation will likely have a zero or two less. Typically follow on rounds follow the same general terms as
the initial rounds when it comes to liquidation preference, participation, etc. So when you get that next term sheet(s)
model out payout scenarios to make sure the terms align with your exit
expectations. It’s really easy for
a fully diluted ownership of 20% to be less valuable than a fully diluted
ownership of 10%. Make sure you
understand the math!
