Early Fundraising Rounds through Venture Capital Rounds
You can plan all your venture company’s funding rounds before you raise a single cent. Even the best-laid plans might cause you to restructure a few things as your company develops. It’s only natural.
You’ll have to restructure the office floor plan to put everyone’s desks in the office as you hire employees, and it stands to reason that you’ll have to restructure other things, too, namely the board and the capitalization table.
The board is one of the main things that will be restructured every time you raise a new round of capital. The board may grow, shrink, or simply change in composition. Your capitalization table, or the list of people who own stock in your company, will also likely change over time.
Later investors may force early investors to sell their shares or to take a different deal. If the early investors refuse, the company will fail to raise money. Early investors almost always allow the capitalization table to be restructured so that they can get something back for their investment. Their maxim: Don’t tip the boat if you are in it!
Tidy your capitalization table
A capitalization table is a spreadsheet that lists all of the people and entities that have invested in the company. For each shareholder, it lists how many shares are owned, the preferences, the series provisions, and the voting rights.
Companies are required to get quite a bit of traction before venture capitalists (VCs) will invest. Therefore, chances are a company will have raised capital at least once before it raises a VC round. Many companies will have done a few early rounds with friends and family, crowdfunding, or angel investors.
If you have a mix of investors, each with different goals, your company will quickly find itself in trouble. At some critical point — maybe your company is in crisis or it’s considering a big exit — you’ll need to bring your investors all together to make a big decision. At such a time, you need your investors to work together like a well-oiled machine.
Put early investors in an LLC
You can simplify your capitalization table by grouping investors into an entity called a limited liability corporation (LLC). If you have a group of investors who invested at the same time with the same term sheet, putting those individuals into an LLC can be reasonably easy.
The individuals are then legally considered a single entity. They vote as one if they have voting rights, and they are represented by a single body in the room in meetings.
Buy out early investors
Sometimes a VC chooses to buy out early investors to clean up the capitalization table. As you can imagine, this solution may disappoint the early investors: They get compensated but are ultimately kicked out of a growing company.
On the other hand, many early-stage investors are happy to just get their money back! If your company can’t receive venture capital because of an early investor in the cap table, that early investor either has to give in or he will ruin the company’s chances of getting funded. After all, any percentage of a defunct company is zero dollars.
Renegotiate terms with early investors
Two things can happen when you have structured a deal poorly in the first rounds. One possibility is that VCs will flee from your deal permanently. The other possibility is that you may be able to go back to your first round investors and renegotiate a new deal that will be more attractive to next round investors.
Doing so is often in everyone’s best interests (although structuring a reasonable deal the first time around and avoiding the pain and headache of renegotiating is always the best option).
Because many deals need to be renegotiated with previous investors to move forward with the next round of investment, you may want to warn your early investors of this potential renegotiation, especially when those investors are friends or family.