[Business] Financing for startups
Brad Feld has a great post on venture financing and term sheets for startup funding. He calls it ne of his super-top-secret VC magic tricks . Brad writes about pre- and post-funding valuations of startups. An important point he made was that increase of a stock pool would reduce the valuation. A stock pool is increased at valuation time to make accomadation for employee compensation. I can understand how this can dilute the investors share of the pool, but I dont understand why the overall pool must drop. Here’s an excerpt from his post
…note that the size of the pool is taken into account in the valuation of the company, thereby effectively lowering the true pre-money valuation.
Another piece of advice that he wrote about was about steering clear of warrants in first round of funding. Which made me really curious as to why. On further study of other sources, I encountered other jargon - bridge loans . Putting it all together, I understood that all these are becoming more commonplace these days with VC’s demanding “staged investment”. I can personally identify with these VC’s since technologies like mine (EDA) are very niche and customer driven. Without proof of a concept on core technology, or milestones in terms of actual deployement in companies, it is very difficult to part a VC and his money. However, there is a variation to this concept, wherein the VC invests the full capital in a given round, but may require anti-dilution warrants that are triggered if certain targets are not met by the management. In certain cases, the VC’s may extend loans, as a stop-gap measure in between series of funding. For these types of investments, warrants are issued which give the lender the option to make an additional investment (at terms which are established in the next round). This is beyond the fact that the principal and accrued interest are converted to stock in the next round. Sweet. I suppose that complexity is the real hurdle here. But at the risk of sounding juvenile, is accepting a lower valuation in exchange for no warrants a good thing. Previous valuation act as a benchmark for the next rounds of valuation. I would rather say that warrants would be necessary if both you and your VC’s want a closely knit family. Personally, I would rather issue warrants to VC’s who get what I am doing, rather than worrying all the time about valuation. I believe there is plenty of money for everyone. I think Feld hits the nail on its head in his last paragraph - choose your early investors wisely, they can hurt next stages of funding.