I have been fortunate to invest as a VC and participate in startup boards for the last 10+ years. One of the many things that has changed (for the better!) is the continued smoothing of early-stage discrete financing events. But I believe we can do better.
Market Has Changed (Shocker!)
As the level of capital needed to answer the ubiquitous “product/market fit” question has dramatically decreased, founders are able to extend the life of their companies with far less capital that was needed even five years ago. Market forces of lower-priced, more-efficient outsourced products and services have created lower capital constraints for founders.
Additionally, I credit Naval Ravikant, Baback Nivi and team of AngelList for continuing to make an inefficient early-stage private market more frictionless. Without their brilliant AngelList platform (and earlier Venture Hacks work), the transaction costs associated with these financings would continue to be massive and time-consuming. With the SEC’s new crowdfunding rules slowly coming out, the noise around this market continues to dissipate.
Financing Should Evolve as Well
Many early-stage founders I speak with (understandably) state they are worried about running out of cash before they start seeing strong customer adoption. Founders understand the delicate balance of 1) having sufficient growth capital on the balance sheet against 2) the amount of dilution the market requires of them to finance this growth.
The less dilution, the better, and clearly, the optimal route is to fund your company without any outside equity dilution (or at least at a much higher valuation). The mental energy and time spent optimizing this cash/dilution equation for any founding team is enormous.
Solutions
So how can founders who bring in outside growth capital create a frictionless “line-of-credit” solution that continually maximizes cash while minimizing dilution as the company grows? The answer lies in (gasp) more financing rounds at smaller chunks at valuations that account for progress between rounds. For this to be successful, founders need to be more transparent and investors need to be willing to invest through subsequent rounds.
- I believe startups should optimally have at least 9–15 months of cash in the bank, so founders should manage their “bank line” (investors) to always have these cash levels flush in the company.
- Every company should have 3–5 KPIs that are real-time displayed/communicated throughout the company, and investors should be able to confidentially access this dashboard at any time.
- As investors stay well-informed (and helpful not bothersome!), their ability to monitor progress increases.
- As growth and traction accelerates, and additional capital is needed to grow the company appropriately, financing events can be quick and painless. The group of investors can quickly value the company and put in needed capital as defined by current/projected cash burn and runway.
- Outside of possible pro rata rights, investors should only participate in future financings at the level the founders deem appropriate commensurate with their help and time given to the company.
- Any new outside investors (and always good to have at least one) have been well vetted before the financing event by founders and selected investors to not cause delay.
- Convertible note rounds can be alternated with pricing rounds if smaller amounts are needed.
- Legal fees should (at minimum) be split between the company and investor group.
- This model clearly assumes the company continues to show significant progress and traction; otherwise, the “bank line” will close quickly!
Founders and investors have to start thinking differently about financing, and paradoxically, I believe more (but smaller) financing rounds can lead to greater time and valuation efficiency around these historically time-sucking events for both sides.
Recipients of this post are not to construe it as investment, legal, or tax advice, and it is not intended to provide the basis for any evaluation of an investment in any fund. Prospective investors should consult with their own legal, investment, tax, accounting, and other advisors to determine the potential benefits, burdens, and risks associated with making an investment in any fund.
