Many first-time founders start a company without really knowing how they will get it financed. And truth be told, the process of financing a company through successive financing rounds can seem daunting at first. But not to worry! We’re here to help!
This post if the first in a series of posts about financing rounds. With each related post, we’ll add a link back to this post (and vice versa) so you can find your way around more easily.
A Six-Step Process
For the purposes of this post, let us assume you have already got your pitch deck ready (or just about). With that in mind, we always like thinking of a financing round as a 6-step process. Each step will influence what you will need to do in the following step.
Determining the size of your raise
Determining the amount of money you want to raise is a function of the stage of your company’s development, it’s pre-money valuation and your dilution analysis. If you hop over to StartupCommons, you’ll see that they’ve outlined the stages of development from formation to validation, to growth.
Your company’s pre-money valuation will tend to grow over time as your company moves through these stages of development, and this translates into the pre-seed, seed, series A, series B, and later financing rounds. The more your company raises at a lower valuation, the more equity you give up and the greater the dilution the founders will have to absorb.
For more on determining the size of your raise, see here.
Identifying your investors
Identifying investors may seem easy enough, but selecting the right lead investor for your financing round is an important consideration. Is a strategic investor the right fit at an early stage? What’s the difference between an angel and a VC? All good questions. But in identifying the investors for your round, you need to think about what industries specific investors are interested in, the technology verticals, whether their funds are currently looking for new investments, and what size of investment your potential investors usually make.
Establishing the terms of the offering
Establishing the terms of the offering involves deciding on the type of security you want to offer, the forms of the documents you will want to use, any accessory arrangements and setting a closing date. SAFEs and convertible notes tend to be useful in earlier rounds (readily available form documents, typically less legal fees and quicker), and convertible preferred equity tends to be more common in later financing rounds.
Investor due diligence
Investor due diligence will vary by development phase, industry and specific investor requirements. But you can expect that your investors will want to review your business strategy and operations, corporate & legal matters, financial matters, your intellectual property and tech stack, and of course, your personnel and related HR matters.
This can be a lengthy process and will involve granting the investors access to key company information, much of it confidential in nature. So dust off those NDA templates!
The document sprint is where the lawyers roll up their sleeves. This step involves preparation of first drafts (usually by the company’s lawyers), and the review and comment on those drafts by investor’s counsel. The lawyers keep iterating on that process of drafting and reviewing, until everyone is satisfied and all of the documents are finalized.
This process usually runs right up until the day before closing.
Finally, we get to the closing of the financing round. This involves first sending all of the documents out for signature (these days, that tends to get handled through electronic signature platforms like DocuSign). When everything is signed, the investors wire funds to the company (or its counsel’s trust account), and the company will then issue the securities described in the offering to the investors upon receipt.
Then – and this step is optional – you pop some champagne!