An Immutable Law of Nature | The First Offer In IS The Best!
By Anne Marie Maduri ● February 05, 2015 16:00
AN IMMUTABLE LAW OF NATURE | The First Offer In IS The Best!
OBSERVATION 1: The first serious investor that comes forward in a financing round always delivers the best terms.
I’m still waiting (and hoping), breath abated, to see an exception to this ‘phenomenon’ … as earlier on in my career, I too, would have been skeptical of such a categorical statement.
Today, after assisting many companies to secure investment, I’m compelled to accept it as ‘matter of fact’, as if it were an immutable law of nature.
SUGGESTION (actually, an exhortation): When a serious investor comes calling, and although the terms may not be ‘ideal’, accept the deal/ funds.
RATIONALE: A company seeking financing is usually not in a position to negotiate. Furthermore, an investor who is actively pursuing the deal (which is scarce) is committed to the company’s success and will likely turn into a ‘partner’, aligned with the founders/ managements’ interests, versus a pure ‘financial investor’. As the relationship develops, and trust is built, the terms may be ‘adjusted’ to more closely satisfy the requirements of both groups.
OBSERVATION 2: Companies that defy this ‘phenomenon’ and turn down the funds ultimately do secure financing. However, the timeline tends to be extended (i.e. the deal drags on and on …) and the terms are more stringent, likely even onerous.
The full ‘cost’ to a company that turns down its first funding offer is significant:
- The value of the company is eroded, as growth is forfeited given the delay in capturing the market opportunity, and
- The morale of a team is damaged. This is usually further compounded by a departure of more experienced members.
Simply put, despite a company’s subsequent efforts, a ‘full recovery’ is forever forfeit.
Management’s primary concern in accepting this first investor’s terms is usually dilution or “we’re giving up too much”.
Again, I urge companies to take the funds - all the while suggesting they consider the following:
- Angel Round: Why set the valuation at the concept stage? Take the funds under more flexible terms, and peg valuation in the subsequent round, when the company has a prototype and a preliminary framework of a business model is delineated (i.e. when a broader basis for valuation is established).
- Seed Round: If the company is poised for high growth, why get bogged down by valuation? The value of the company is significantly enhanced as it immediately and effectively exploits the market opportunity, especially in high growth market. The principle, prosaically stated, is that "a small slice of a large pie is worth more than a large slice of a small pie". The bet is that the increase is valuation is exponential (versus linear). This is proven time and again.
To further assuage management, options to subsequently ‘recover’ a portion of their deemed ownership position include getting the Board’s approval to:
- construct compensation packages that comprise base salary + performance pay that include options and/or stock with step ups.
- borrow against future income and ‘purchase’ the cheaper stock.
At the end of the day, my advice is this: be creative, fair and realistic. Devise to devise a panacea – but first and foremost secure the funds!
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Anne Marie Maduri is a finance specialist and ideaBOOST mentor. Maduri & Associates provides investment banking and advisory services to companies in the Digital Media Entertainment and related technology sectors.