Post-money valuation explained
Preparing to talk to potential investors? You’ll need to know your pre from your post-money valuation. In this post, we...
Raising startup funding is a slow and expensive process. You have to decide the amount you want to raise and set a valuation. Then, you need to round up enough investors to reach your funding target. Then you negotiate the deal terms to come up with something that works for everyone. Then you need to create the legal docs for the round and get all the investors to sign.
The entire process is so complex, painful, and expensive that the startup world has evolved a 12–18 month funding cycle. That is, your goal is to raise enough money to last 12–18 months. Of that, you spend the first six months raising money (during which you’re focussed on finding investors and the legals rather than running and growing your business), then six months using the money, then, with only six months’ cash left in the bank, you frantically start the process over again, hoping that you have enough traction to raise another round before you run out of cash and the business hits a wall.
It’s a brutal repetition of find investment, grow, find-investment-or-bust.
Imagine an alternate universe, one where those 12–18 month cycles are replaced with continuous investment. Instead of having to raise enough money to last a year or more and round up a group of investors to all get on the bus at the same time, you can top up on demand.
You’re at a dinner telling people, as you do, about your amazing startup. One of the guests says, ‘Hey I love the idea, can I invest £10K?’ ‘Sorry,’ you say, ‘I’m done on my last round, let me get back to you at my Series A next year.’ Opportunity lost.
Now imagine that instead you say, ‘Brilliant, what’s your email? I’ll send you a link to my deck and deal docs. If you like what you see just click to e-sign and wire the money’. The investor will get a share certificate to confirm their investment, and shortly afterwards the certificate to confirm their SEIS/EIS benefits.’
Here’s how you can use Instant Investment to do exactly that.
From a VC’s point of view, those 12–18 month cycles are convenient. VCs play the numbers game, investing in dozens of startups. Some will scale, others will die. VCs are overwhelmed with investment requests, and the 12–18 month ‘grow or die’ cycle forces those requests into a form that allows them to categorise rounds, traction and valuation as Angel, Seed, Series A, etc.
You raise money based on promises you make (technical delivery, traction, revenue), and hitting those goals is key to raising another round.
VCs see the brutal 12–18 month cycle as a way of winnowing out the weak — i.e. the failure of a company to round up the full complement of investors for their next round is a good indicator that the company isn’t going to be the next unicorn, and so imposing this regime is a good indicator of success.
From the startup’s perspective, it’s the opposite. Let’s face it, there are over 20,000 growth startups launched each year in the UK, and perhaps a couple of unicorns a year. Statistically you’re not going to be a unicorn. But that’s perfectly fine, you don’t need to be a unicorn to have a valuable and profitable business that provides a great return to your investors. Why do you have to go through an insanely stressful cycle of funding rounds which, if you fail on any, sees your business crash and burn?
The good news is that this is already changing, see the rise of the Salami Round.
Doing all the paperwork for a funding round is, or at least was, a hugely time-intensive process. Redlined Word docs circulated back and forth between the lawyers for each party as each party’s lawyer fiddles with the wording to insert clauses designed to protect their client’s interests. Or simply to change the wording to reflect their personal or house style, no matter whether those changes are beneficial or just noise (“please change Founders to a lower-case f”). Those legal costs can easily run to £10,000 or more on a £500K round.
So it’s no wonder that historically it made sense to group investments into a few big rounds rather than lots of little rounds.
The good news is technology is rapidly changing that. The decades-old lawyer-to-lawyer exchange of redlined Word docs is being disrupted by legaltech startups like SeedLegals.
Now it’s time for the next step.
When you do a funding round, the company and the investors sign a Shareholders Agreement and adopt an Articles of Association which contain terms that prevent the company from issuing more shares without the consent of the investors. The reason is that the big fear that investors have (other than the company going out of business) is that the founders will create zero-cost shares, for themselves or friends, thereby diluting the investor’s stake in the company.
To prevent this happening, the funding round docs contain provisions that require shareholder consent to issue more shares, and also to give investors the right to buy any newly-issued shares to maintain their existing stake in the company.
These provisions prevent founders from taking an investment from a person they meet in the pub, as they don’t have the power to issue shares for that new investment.
This problem wouldn’t exist if this scenario had been thought about at the time of the last funding round, when the funding round deal documents could have been drafted in a way to allow this, whilst still providing all the necessary investor protections.
If you think about it as a game of chess, most times everyone is so keen to just complete a round that it’s equivalent to playing a game of chess looking just one move ahead. But each move contemplated not just what you want to achieve now, but also a few moves ahead…?
Instant Investment changes everything. By building the ability to take additional investments into existing funding round deal documents, then using technology to automate the legals and company-investor communication for additional investment, you now have the ability to do a small initial funding round, raising only what you need or just the investment you’re able to get right now, and then top that up anytime, within limits agreed in the initial funding round.
Here’s an example:
Let’s say that NewCo is looking for £500K in investment, at a valuation of £2M.
Normally that would mean they need to find investors for that full £500K before they could close the round and get any money in. It could take months.
Now, as soon as they have, say, the first £100K of investment lined up, the founders can choose to do a funding round of £100K with ‘up to another £400K of additional investment allowed anytime in the six months following the round’.
That allows the founders to quickly close the round, bank the first £100K, and get on with growing the business.
Then, at their leisure, each time they find an investor, in just a few clicks they can send them a link to view the deal documents from the last round and a Deed of Adherence to sign to complete their investment. It’s that easy.
Of course this has been possible in the past, but the combination of lawyers not having an interest to promote micro-transactions (if you want to think of them that way) that run counter to their manual approach to building documents, and the fact that without a legaltech platform to automatically generate all the documentation and allow for online signing, the transaction overhead was just too high to make this practical for widespread adoption. All this has now changed.
Welcome to a new era of ‘continuous funding’, augmenting and sitting alongside traditional funding rounds, giving founders and investors more flexibility to grow and scale their businesses, and to make investments on demand whenever they come across an interesting opportunity.