Guide on Investment Rounds for a startup
Conducting an investment round for a startup or an emerging company is perhaps one of the key milestones in its journey, and even in its own survival.
In this first post, which serves as an introductory presentation of the process, we will not focus on analysing the term sheet or the investment agreement.
Instead, we will provide some preliminary considerations that every entrepreneur or investor should evaluate before considering investment rounds for a startup or, in the case of an investor, before investing in a company with the potential for a dream x10 return.
Investment Rounds for a startup: essential aspects
The first thing to consider is that each startup is unique, and its growth path and financial needs don’t necessarily align with those of other startups in its environment.
Many times, we simply refer to rounds like FFF (Family, Friends, and Fools), seed, series A, series B, etc., assuming that they all follow a specific timeline. For example, in the first x months, we need to conduct an x round. This is not accurate.
Founders and their expert collaborators will be the ones who, based on their business plan, determine when a financing round needs to be pursued or when they decide to increase the share capital to bring in partners who can add value to the company.
In many cases, we think that capital increases are only carried out due to liquidity needs in the company’s funds. While it’s true that these situations are the most common, the reality is that new partners can also enter the company due to reasons such as the addition of a strategic partner.
This partner could be valuable due to their expertise in the sector, their industry-specific knowledge, or because they can meet the company’s manufacturing needs for its product, and so on.
Let’s start with a premise that I like to remind my clients of: seeking profiles that complement the company’s needs is a good idea, but one should not forget that it’s easy to bring a partner into the company, while achieving their exit without consequences for the company is much more complicated (alternative solutions like phantom shares or stock options can be explored).
Therefore, when conducting an investment round for a startup it’s crucial to analyse the company’s needs in harmony with what’s outlined in the business plan, which is a dynamic document that should establish the essential guidelines for the startup in the short or medium term.
To help the reader understand the significance, I will present two real scenarios that I’m currently working on alongside the drafting of this post. Companies A and B both have a share capital divided into 3,000 social participations.
They are limited liability companies with an approximate pre-money valuation of 1,5 million euros, and both have an estimated lifespan of around 2 years.
Company A is seeking an investment round of 250,000 euros because the founding partner calculates that, given the nature of the digital service it provides, this amount will provide sufficient resources for the next 6 months. During this time, the company expects its product to gain recognition and become self-sustainable.
In case B, a company that has already completed the MVP (Minimum Viable Product) and wants to produce its product for commercialization and recruit key high-value profiles, is seeking to raise between 700,000 – 800,000 euros through the investment round.
As we can see, two companies with essentially similar parameters (and this is exactly the trap, as these parameters don’t provide sufficient information about the company) present different needs. Consequently, for an investment round:
- The founder must be capable of identifying the company’s needs, developing a solid business plan, and conveying to potential investors that the intended round of funding will elevate the company to the next level.
- On the other hand, the investor will seek to understand not only the numbers but also the project, the plan, and the founding team. In many instances, especially during early stages, investments are made more with the “heart,” deliberate quotation marks, or in other words, valuing the true potential of the project rather than relying solely on metrics like EBITDA five years down the line.
In the upcoming post, we will initiate the process of investment rounds for a startup by delving into the often-underappreciated preliminary work. This phase is truly crucial for the success of the round – including the creation of the investment deck and the selection of the right investors.
Letslaw by RSM is a law firm specializing in comprehensive guidance for startups and the commercial law area. Do not hesitate and contact our team of commercial lawyers.
Letslaw es una firma de abogados internacionales especializada en el derecho de los negocios.