Raising Capital Today, Liquidity Tomorrow

 

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!

Comments

[Joe C]

Dead on. We fell into this same trap many years ago and it ended up being a real problem as we got closer to an exit. It finally got resolved but there was definitely some bruised relationships between management and the investors afterwards.

[Nikki Lang]

Wow I had no idea so this is very helpful. I am close to completing my book to investors so I have been looking for tips on early stage investing and this has been a huge help. Thanks.

[adult chat]

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