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Pros/Cons of delayed valuation in an equity raise

Hello,

Am looking for feedback on potential pros/cons of an investment proposal that we have received from a group of investors (syndicated seed round). Basics of the proposal are as follows:
  1. They give us the investment in series of tranches
  2. Release of tranches based on agreed upon milestones
  3. Exact Valuation of equity to determine investor stake is delayed for 2 years. Instead an upper and lower limit to the valuation is given
  4. Milestones are set for the end of the 2 years. The milestones we hit determines the valuation (the more we hit, the higher the valuation). If we hit no milestones
  5. Exact instrument of the investment would beCCPS (Compulsorily Convertible Preference Shares). This would capture the base and maximum valuations in the agreement. Based on milestone performance, conversion ratio of each preference share to equity share varies (e.g. :1 (in the best case) to 1:5 (in the worst case))
Thank you!

10 Replies

Starlene Sharma
0
3
Starlene Sharma Entrepreneur
Inclusive Business and Tech for Development Enthusiast
Hi Bryan, Question lies in your confidence to meet numbers and if you are confident try to push the upper valuation up :) Starlene
Michael Brill
9
0
Michael Brill Entrepreneur
Technology startup exec focused on AI-driven products
Ugh. Where are you?

Complicated shit like this always ends in tears for everyone. You miss a milestone (and you will miss a milestone) and then what? If you're doing well then you start gaming performance. If you're not doing so well then they get all the equity and you have no incentive to turn it around. You're always a puppet and even if the investors mean well, their clear instinct to control will create so much meddling that you can't do your job.

Set a valuation now or let someone more competent set a valuation later. We can all point you to *thousands* of companies who have made tons of money for their investors with simple structures. Ask the investors to show you five - just five - companies who have made money for their investors with this structure. If they can't do that, then they have no right to propose the structure.

Chris Carruth
0
0
Chris Carruth Advisor
VP/Director. Strategy | Business Development | Operations | Product | Solutions

I see their point, but I also see the issues Michael B brings up. In my area most large financial firms will not do valuations for start-ups due to liability issues. Convertible debt is a route some take to avoid valuation issues in the early stages so perhaps there is a way to simplify it via this mechanism.

Other question is - do you have other sources you have talked to where you could leverage this interest to gain better terms and avoid dealing with this source for now? Once established you could always go back given they certainly have interest in the team/product/market..

Peter Sankauskas
1
0
Peter Sankauskas Entrepreneur • Advisor
Founder & CEO at CloudNative
Why are people not using the standard YC SAFE docs?

Is there something unfavorable about them?
Steve Simitzis
9
0
Steve Simitzis Advisor
Founder and CEO at Treat
Set this deal on fire and run. Do you want to be a founder or an employee of your own company? Because that's what you're deciding here.

Let's start with milestones. If you're a startup, expect to pivot. Your product will change, your metrics for success will change, and so your milestones must change too. Locking in milestones at the onset locks you into a single strategy that you must execute on for two years or lose your funding. Not only is this bad for you personally, it's deadly to your business. You must be willing and able to adapt your course as you discover who your customer is and what they want.

Investors are not running your company, and they can't predict the future. No one can. If they *could* predict with certainty what would turn your business into a success, they wouldn't invest. They'd hire an agency to build it out, and put together a budget, with milestones. Sound familiar?

Inevitably you're going to miss the moving target. Then what happens? The investors get five times as much equity, diluting you to barely anything. In other words, you hand them control (I'm assuming they wrote the worst case scenario to give them more than 50%) of your company for free. They bundle up the company as an acquihire, they get their money back, you get a job at Yahoo.

Here's your counteroffer:

(1) No milestones, no tranches. They invest all the money they're willing to invest now. If they're unwilling to invest more before seeing progress, okay, no problem, they can invest more at the next round.

(2) If no one wants to fix valuation, then do a convertible note, uncapped. They won't agree to uncapped but it's irrelevant. Their offer is so extreme you'll have to go all the way to other side of the globe before you can find a reasonable middle ground on a cap. Limit their ownership to 20% in any scenario.

(3) No board seats.
Michael Brill
1
0
Michael Brill Entrepreneur
Technology startup exec focused on AI-driven products
(4) And at least 2 pies. They owe you something for that horrible offer. if you get the pies, please share with contributors here.
Robert Tolmach
0
0
Robert Tolmach Entrepreneur
Entrepreneur and Social Entrepreneur
Good post, Steve. Glad to learn of your site,http://www.hashtagclimate.org/, too.
Dirk de Kok
0
0
Dirk de Kok Advisor
Founder and CTO Mobtest
yeah, that sounds overcomplicated that will cost you a lot of money in lawyers to get the documents drafted.

1 - do convertible notes with a cap, not a bottom
2 - give them a discount for your next round, like 20 %
3 - make sure you raise money for at least 18 months
Bryan Lee
0
0
Bryan Lee Entrepreneur
Krishi Star
Thanks everybody for the feedback here, some really interesting perspectives that make a lot of sense. Just a additional points that could add to the discussion
  • Our venture is in India, some of the investors are US-based - this might limit legally some of the options as US entities cannot issue debt to Indian company. I'm s
  • At bottom range of the milestones (from our perspective) is not above 50%, it's actually closer to 20-30%
Thanks!

Michael Downing
0
0
Michael Downing Entrepreneur
Founder & CEO at Tout
That structure in general is a train-wreck waiting to happen.

  • If you can't do debt, then price a small low-valuation $1MM on a $4MM pre-money (for example)
  • No performance tranches
  • Allow them to only provide 25%-30% of the round
  • The ultimate way to make this work - find additional investors who want in and create competition (the only way to CLOSE a round)
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