Raising capital can be a drawn-out process that costs the company the time of the founder, legal fees, and investor goodwill. As time drains a company’s existing funding and new cost mount, fundraising will demand the full attention of the team even beyond the founder. There is also sometimes a concern that the investor will lose interest if the process drags on. In the most dire terms, founders often give up deal points just to get the investment closed, so a smooth transaction has its rewards. Here are some tips for founders to consider before setting sail, all based on real deal experiences.
Build the Coalition
Every investment round will demand the cooperation of some existing stakeholders in the company. Cofounders, existing investors and other key principals may well be in different economic and even personal situations. Although the fundraise should be their priority, it’s possible that any of these stakeholders might have a particular sticking point around the structure of the deal.
CoalitionLess Ltd were raising a sizeable mid-round of funding. They had a small group of existing shareholders: founders and employees plus a couple of early-stage investors. The shareholders were supportive when CoalitionLess decided to raise, and the founder team started the process. CoalitionLess is a good business in a hot space, and attracted plenty of attention. After some time working through termsheets and diligence requests, CoalitionLess’s founder team had agreed full commercial terms with an investor group.
The founder team then went to CoalitionLess’s shareholders to show them the agreed termsheet. Most were delighted, but one shareholder declared that having now seen the terms they would rather sell out. The shareholder had a large enough stake that the transaction couldn’t complete unless they (among others) approved, so CoalitionLess had to take this back to the investor group. The investor group didn’t want to proceed on that basis, and so CoalitionLess had to renegotiate the round.
There is a clear time cost for the founders in having to keep stakeholders updated, so some balance is required. Passing on every detail of every version of the proposal would likely be unnecessary, but updating key stakeholders on the broad terms of the transaction is usually worth the time.
Don’t Reinvent the Wheel
There’s no established market standard for early-stage investment terms, and even later round transactions regularly deviate from the norm. There is however a common set of features used in most transactions, which tend to be implemented in similar ways. Those features can work differently, but doing things in a way well outside the norm takes far longer than sticking broadly to the standard.
Take NewWheel Ltd.’s leaver provisions as an example. Leaver provisions are clauses that cover what happens to an employee’s vested equity when they leave a company. Very broadly they look at the reason why the employee is leaving and tag them “good” or “bad” leavers. Bad leavers are then forced to sell their equity for a token price, and good leavers either keep their equity or sell it for market value. There is always some discussion when these provisions are implemented, principally around which reasons for leaving are “good” and which “bad”, but those discussions can be concluded quite quickly.
When NewWheel had that discussion, there were certain leaver scenarios that they weren’t willing to class as “good” or “bad”. They also felt that early “co-founder” shareholders should be treated differently. Long discussions with their incoming investor eventually produced an agreement that leavers could be “moderately good” and “moderately bad” as well as the usual two categories. Co-founder shareholders could only be “good” or “bad”, but with better treatment in both cases.
Writing documents to reflect this very different model also took significant time. Each version of the documents went to lengthy review, with comments from the directors of NewWheel as well as their incoming investor and their lawyers. All sides were trying to make sure that this new and unfamiliar implementation worked properly. This word-by-word negotiation of the leaver provisions cost NewWheel, in founder time and legal fees, about the same as the rest of the transaction.
There’s nothing wrong with wanting things to work in a particular way. If the company wants it, and the investor will accept it, then there is always a way to implement it. But going outside what is “standard” does have an effect on the timing and cost of the transaction, and founders should be aware of that.
Use Lawyers Properly
It might seem unlikely, but getting lawyers properly involved makes the process more efficient than when they are kept at arm’s length. The lawyers will create the final documentation, and the better they understand what the company and investor have agreed the more efficiently they’ll be able to do that.
Oz Corp decided to save money by keeping their lawyer completely out of all discussions, behind the proverbial curtain. They wanted the company and investor to discuss the commercial terms, and then hand over to the lawyer to draft the documents. Oz’s incoming investor was happy to save some cost by using a single firm. Although some terms were agreed, there was plenty that needed to be clarified. Oz discussed its lawyer’s list of questions with its investor and fed back the results, but they had not got full answers and further detail was needed. This process repeated, taking a few days each time, with Oz’s founders and the investor becoming increasingly frustrated.
Eventually Oz refused to discuss any more questions. Drafted on incomplete information, the documents the lawyer produced differed considerably from what Oz’s investor had wanted. With the investor now threatening to pull out, Oz invited the lawyer to join the next discussion. As the lawyer was now able to speak directly to both parties, the remaining issues were settled quickly and the round closed.
The goal is to establish an efficient route by which the agreed terms can move from the parties to the documents. Lawyer-to-lawyer communication, where both sides are represented, is usually the main one. Adding the lawyer(s) to email chains, con calls and meetings is often helpful even so. Where there is no lawyer on the other side, or they have been engaged on the basis that they’re only there to answer their client’s questions when asked, it can be vital.
Ensuring that key stakeholders are on board with headline commercial terms can help to avoid having to attempt renegotiation at a late stage. At the least, a late request for a significant restructuring will cause a significant delay. At worst, as for CoalitionLess, it can derail the entire transaction.
Using provisions that are broadly in line with standard, rather than reinventing the wheel, will also keep cost and distraction to a minimum as all parties will be able to review efficiently. As NewWheel discovered, going back to first principles can bog the process down in long and detailed discussion.
Engaging lawyers properly, ideally once the termsheet has taken shape but before it’s finally signed, will enable them to pick up on areas that need to be fleshed out for the final documents. Oz’s preferred model, limiting the lawyers’ access to the information they will need to draft the documents, is usually a false economy.
One size doesn’t fit all, and there may be good reasons to pursue things which will slow down the investment process. Where everything else is equal, however, an investment process that is plain sailing is generally good for founders and the company and helps to ensure that commercial terms are not sacrificed to relieve time pressure.