Next steps in the guide on investment rounds for startups

Next steps in the guide on investment rounds for startups

Finally, today we reach the last section of the guide on investment rounds for startups. So far, we have been delving into the interests, types, and various circumstances that affect these processes, which are crucial for the life and survival of startups.

In this installment, after the guide on investment rounds for a startup, we will summarize the procedure for an investment through a convertible note, the most common expansion mechanism nowadays. As we know, the investor will sign a convertible loan in shares of the company under specific conditions.

Disclaimer: I recommend that the reader refer to the previous parts for better comprehension.

Previous steps in the investment rounds for startups

In the initial phase, the founders (assuming we are in a pre-seed stage) have analyzed, as discussed in earlier articles, such us the investment rounds, an extended guide for entrepreneurs, how much capital they need and what the pre-money valuation of the company is, based on standard indicators and the growth outlook of the company.

By dividing the pre-money valuation by the number of existing shares, the founders have calculated the value per share, including its premium and nominal value. To simplify, let’s consider an example: suppose they have valued their company at 300,000 euros, and their share capital, typical for this stage, consists of 3,000 shares with a nominal value of 1 euro each. Therefore, the value per share will be 100 euros, with a nominal value of 1 euro and a premium of 99 euros.

Additionally, the founders have already conducted various pitches and hired a Fundraising service (such as the one provided by Letslaw). As a result, they have connected with potential investors to whom they will send a Termsheet (outlining essential investment elements) or directly the convertible note that will regulate the granting of the convertible loan.

Once sent, the real negotiation begins when the founders formalize what they have previously communicated. In the pre-seed stage, discussions usually revolve around whether the pre-money valuation is realistic and whether to include a cap and/or floor in the conversion valuation. The cap benefits the investors, and the floor benefits the company.

Investment rounds for startups: additional rights for investors

Furthermore, investors are likely to request additional rights, such as those aimed at exerting some control over the company (e.g., appointing a board member or an observer, establishing a qualified majority regime for key decision-making, etc.).

Additionally, they may request terms related to a future exit of the company, making a follow-on investment in subsequent rounds, including a clause protecting them in case of a down round (i.e., the next investment round occurs with a pre-money valuation lower than their entry valuation) or a commitment to the founders’ continued dedication to the company.

From our experience, the two essential elements in this stage are determining entry percentage in the capital and company control clauses. However, all investor demands should be considered together and negotiated accordingly.

A preliminary recommendation before the investment round, which I find quite useful, is to have a pre-agreed shareholder agreement among the initial partners. This agreement lays the foundation for relationships between partners and partners and the company, giving the founders a stronger negotiating position, as it involves modifying something existing.

If the investor presents the agreement, it will likely be more aligned with their interests. Once these points are negotiated and agreed upon, the next step is to sign the convertible note with the future partner, now a lender, and the loan amount will be deposited into the company’s bank account.

This process should be carried out with each potential partner, ensuring that the conditions do not differ significantly (except for the financial amount). However, for key profiles or the lead investor, a discount on the pre-money valuation can be negotiated so that, for the same investment, they receive more shares.

Once this process is closed, the capital expansion will be executed, but that will be the subject of the last article in this series. If you need advice on investment rounds for startups, our Letslaw by RSM team of commercial lawyers and startup lawyers will be happy to help you. Do not hesitate to contact us.