RAISING EQUITY CAN BE LIKE A GAME OF CHESS

Most often the entrepreneur will need additional rounds in the future, unless this round is the last of several rounds.

A typical comment that I might hear from an entrepreneur is this- "I am looking to raise $2 million dollars for a 40% share of the company."

 
When I probe deeper, I find that is usually where it stops.  Questions like these below aren't thought of:

• How many more rounds will be needed?
• When will the additional rounds take place?
• How much will be raised in each of those rounds?
• What shares will be set aside for management?
• What will the final exit be and at what price?

The entrepreneur may not be thinking of these questions, but the potential investor will.  It comes down their assessment whether this investment will earn the expected return for them.  But don't just rely on the investor's judgment- do your own planning ahead of time and come up with your own set of numbers.  They will be impressed that you took the time to look at things from their point of view, in a way that almost nobody does.

We build this into the financial models we do for clients where an equity raise is involved.  This is important enough that we set up a separate equity sheet in the projections.  There we show:

*         What we expect the ending valuation to be.

*         The amount and timing of each round.

*         The expected investor percentage at each round.

*         The expected return of each round.

When the model works right, the first round investor gets the highest return, followed by the second round, etc.  They are compensated for the risks they face by coming in earlier.  Another test is the rate of return- does this match what an investor would expect?

 
So look all the way to the end when raising equity.  Be like the chess player and look several rounds ahead.  Otherwise, you run the risk of boxing yourself in with your next equity round.  Too often we see that the first round has been raised at too high of a valuation and it makes raising the next round much more difficult.