Party rounds
To add, or not to add, new investors into your round
I was helping some founders recently whilst they deliberated about which investors to bring into their funding round. They’d already decided the lead investor and were oversubscribed for the balance.
No doubt this is a luxury problem but it’s not always straightforward and requires careful consideration — just like any decision to allow an investor onto your cap table.
Below is the framework we came up with for helping to make the decision.
What am I missing? Whether you’re a VC or founder I’d love to learn from your experience — please feel free to comment and I will update this post accordingly so as to be as helpful as possible to others in future.
(Note: this was for a seed round and assumed: (a) the company needed additional investors to raise the total capital they needed, and (b) the new non-lead investors wouldn’t have a board seat)
Reasons to bring an additional investor into the round:
- Brand: is the investor’s brand strong and relevant enough to be a positive signal for your company in future funding rounds and senior hiring?
- Experience: does the investor have specific knowledge or experience that could help you grow the business and is additive to the investor group?
- Network: does the investor have a network that could be valuable to you in building the company (e.g. funding, hiring, sales) and is additive to the investor group?
- Loyalty: do you need to honour a pre-existing commitment, or do you feel you owe it to someone who helped you earlier on in your startup journey?
(*The first 3 are about ‘value add’. The final point might seem trivial but is about protecting your reputation, or just feeling good about the process.)
Reasons not to bring an additional investor into the round:
- Squeezing: by bringing an additional investor into the round, will you be squeezing allocations and risking your relationship with other investors?
- Ownership: will any of the investors become so small that they won’t care enough? (hint: they won’t tell you they don’t care but it might be inevitable if their £ investment or % ownership is too far from their target fund model. This level will be different for every investor and you’ll only know by asking lots of questions.)
- Shareholder management: make no mistake, each and every investor will require time, energy and effort on behalf of the founders, even if it’s only one meeting per year. It all adds up.
- Decision making: each investor will have a point of view on future funding rounds, and will need to sign legal documents etc. They might not be able to veto anything on their own but they can be slow or frustrate the process.
- Follow-on capacity: more investors in the round does not necessarily increase future funding capacity. Diffusion of responsibility can mean that non-lead investors see their investment as an “option” rather than a commitment of support they need to honour when times are tough. I’d advocate that fewer investors with larger ownership will feel more obligation to support the company in future.
- Signalling risk: do any of the investors in this round also typically ‘lead’ investments in later rounds? If so, and they don’t step-up to lead your next round, then — at best — it’s something you’ll need to justify repeatedly to new investors in future, and— at worst — it creates a major red flag and puts new investors off completely. (*‘signalling risk’ is a subject that needs it’s own separate post)
- Information risk: all investors will have confidentiality obligations. But, generally speaking, a broader circle of trust leads to to an increased risk of information being miscommunicated or inadvertently falling into the wrong hands.
As with all decisions, there are trade-offs and the benefits needs to outweigh the potential disadvantages and risks for your company at each stage of funding.
For more thoughts on this subject, Sam Altman’s short post is worth reading…
