Winter is literally here. The global amount of venture funding for the third quarter in 2022 was US$81 billion, down by US$90 billion (-53% YoY) and down by US$40 billion (-33% QoQ). Fundraising by issuing tokens have all but dried up over the recent months.
Despite record amounts of new funds being raised by VCs globally, it is clear that investors are sitting on the sidelines. This buildup of dry powder means there will be deployment pressure in 2023.
Following our original piece on the Art & Science of Fundraising, the following are the top 3 things you can do to be ready for fundraising in 2023.
1. Organize the Cap Table
The Cap Table (short for “capitalisation table”), is a snapshot of all your shareholders, the number and class of shares they own, and the percentage of ownership on an outstanding and fully diluted basis.
Before setting up the cap table and bringing on new investors, co-founders should be ready to split their equity. The secret to splitting equity is not to make it equal but to customize it based on each founder’s value-add and time spent working on the project. The first, is to allocate equity according to each co-founder’s contributions, with some flexibility in making adjustments to reflect each other’s increased or reduced time spent on building the company. The composition of the Cap Table can be fluidly changed in the early days, and it only locks up upon the company’s first “priced round”. A priced round is the fundraising round in which a price-per-share and company valuation is agreed upon between an investor and the company, and there is a subscription (purchase) of shares. To add perspective, fundraising rounds that exclusively use convertible notes like SAFE notes are not shared purchase events and are not considered priced rounds.
The second, is to put a vesting schedule in place for all co-founders. All founders should be vesting their shares. In the event a co-founder stops working, it is only fair for the unvested shares to be reallocated among remaining co-founders who remain committed.
A word on token ownership: It is important to understand that equity ownership is NOT the same as token ownership. Tokens could be utilized as one of the company’s products, regardless of whether it is a store of value or being a non-fungible object or representation of one. While it may be possible to fundraise from the issuance and sales of tokens and exert influence over the project, owners of the tokens may not represent ownership of the business or entity. For example, DAO governance tokens may represent votes, but note that there is usually a steering committee that formulates the ballot issues and proposals. Equity, on the other hand, represents legal and economic ownership in the legal entity of the company itself.
ESOP (Employee Share Option Pool): Share options represent a right to acquire actual shares in the future. More about ESOP here. It is critical that founders and team know that new investors will need an ESOP to be established before they invest. Firstly, it is anti-dilutive to new investors. Creating the ESOP is done to reserve future shares before the investor invests so that it only dilutes the current shareholders. Make sure you have your ESOP created and ready to avoid funding delays and extra negotiations during the closing of the round. Avoid going into overtime because, as the old sales adage goes, “time kills all deals”.
2. The Data Room
A virtual data room is a secure online platform that allows users to store and share sensitive or confidential information. This provides a secure and efficient way for organizations to share information with external parties, such as potential investors or partners, while maintaining control over who has access to the information. In a virtual data room, users can upload and share documents, conduct secure communication and collaboration, and track and control access to the information.
The earlier stage your company is, the less information you have / need to provide. The later stage your company is, the more you should provide.
Major folders in the data room include, but are not limited to:
- Corporate registration documents, business licenses, register of members and the cap table
- Key business documents: pitch deck(s), contracts, projections, audited financials or management accounts, marketing materials, pipeline and operating metrics
- Legal contracts: investment documents, partnerships, employment contracts of key employees, shareholder agreements, ESOP, loan agreements, other off-balance sheet documents, investor updates and board materials
The most underutilized aspect of the data room is the opportunity to continue the conversation with your prospective investors. Storytelling doesn’t start and end with the pitch. Leverage the narrative during due diligence; an often overlooked place to do that is with the data room. Ensure your data room has the ability to track behavior – Sprout’s data room logs investor interactions with time stamps so you know what documents and when the investor looked.
3. Leverage Financial Projections
How much should you raise? This is a universal question for founders and their teams. In short, you will need the cap table and financial projections to answer this question. Preparing financial projections will not only describe how the business will grow numerically, but also help guide your fundraising conversations with investors.
How many months would that be? The rule of thumb used to be 18 months, but as we mentioned earlier, investors are now saying 24-30 months, with a 20% cushion, to get through the current environment. The financial projections should map the burn over these months and fit with the amount being raised to create a runway to your company’s next major milestones. The amount raised should also be considered together with your cap table. As a rule of thumb founders should try not to sell more than 20% of your company in the early stages of the fundraising journey.
Once you have found the amount you are raising with the percentage of equity you are willing to sell, you should run a scenario analysis on the cap table to see the impact of dilution on existing shareholders. Remember to consider the hidden dilution from convertibles – if you have previously taken bridge financing or SAFE notes, these instruments will convert into shares upon the priced round. You should also read the convertibles’ terms carefully to know if the convertibles convert before or at closing. This impacts new investors coming into the cap table, and they will ask about the expected dilution, so it is better to be prepared by having modeled out the post-investment cap table.
Congratulations if you have read this far. Our parting thought is to let you know that you are not alone. Sprout can help you prepare on your cap table, organize your virtual data rooms and model your ownership outcomes. Sprout offers a pricing option that is suitable for your business regardless of where you are in your business journey schedule a demo today.