     |
Understanding First Round Financing
It is important to understand the nuances of your First Round Financing. You have to think of financing like a chess game. You have to think 2 or 3 steps ahead. Most companies don’t raise venture capital financing in one round without the need to raise financing in two or three subsequent rounds. First round financing therefore becomes important for several reasons. 1. If you give away too much equity (your company’s common or preferred stock) in the first round, you have greatly diluted the ownership position of your Management Team. For instance, if you give up 45%, and you are likely going to need subsequent financing, then the result will probably mean giving up voting control of your company to raise more capital. Of course, if you can convince subsequent round investors to give you Super Preferred voting rights then you may be able to maintain voting control, even if you loose majority ownership in the company. 2. Venture Capital firms typically like to control the whole deal. This means if you give up to much in the first round financing, you will be at their mercy in subsequent rounds. They will take advantage of the fact that you are desperate for more cash for the company. They will also have the deal structured so that if you refuse to give up control in a subsequent financing round, they will be able to take over the company and replace management. They can do this by structuring the financing terms with a number of different “default clauses”. For instance, if you default on a payment or don’t meet certain goals that have been established. 3. Another problem with not understanding all the implications of first round financing is that it can restrict your ability to raise subsequent financing. For instance, let's say you and the investor(s) that provided the initial funding have a disagreement and you decide to go elsewhere for more funding. This second round investor is going to look at all documentation on the initial funding you received and may even want to talk to the first group that funded your company. There may be restrictions on subsequent rounds that scare other investors away. I am talking about restrictions like, rights of first refusal, Security Agreements that run in favor of the initial investors and clauses that prevent you from giving other investors more voting control or a better stock purchase price than the first investor group. You need to have competent legal counsel to advise you during the first round of financing. It is extremely important to know the impact subsequent financing rounds will have on management’s stock ownership and voting control. That is why you need to carefully analyze and understand your first round of financing. If not properly negotiated and understood, it can have devastating effects on your subsequent rounds of financing or your ability to even obtain subsequent financing.
|
