By Anthony Rose, CEO & co-founder SeedLegals
Over the past decades, startup funding rounds have evolved into a pattern of raising money every 12-18 months, and having to raise enough to last the next 12-18 months.
Why is that, and is that the best way to go?
A key reason for this 12-18-month cycle is that the time and cost of doing a funding round is large – lawyers charge a fortune, the back-and-forth negotiating deal terms takes ages and founders have to devote a good chunk of time to the process.
And that leads to the current pattern:
• Because of the time and cost of doing a funding round, you want to do it as infrequently as possible,
• It takes perhaps 3 months to find investors,
• And then perhaps 3 months to close the round,
• Then, after your round, you’ll need 6 months to hit a new set of growth or revenue targets that you’ve promised your investors,
• And you need at least 3 months’ worth of money in the bank to avoid the risk of trading insolvent as you deplete the amount you’ve raised.
Add it all up and you get to the current 12-18 month ‘go-big-or-go-bust’ funding round pattern.
For the founders and the startup team, this is an immensely stressful process – each time the bank balance is slowly exhausted, you’re living with the knowledge that without raising another large funding round it’s game over for everyone.
Also, by having to raise 12-18 months of money at today’s valuation, you’re giving away a lot more equity than if you had only needed to raise enough to last, say, 6 months, and you could use that money to get traction and allow you to raise more at a higher valuation further down the line.
In the current model, startups are forced to pretend that they require vast sums of money all at once. The reality is that companies aren’t designed to function like this. A startup likely doesn’t need a million pounds today – instead, they need a much smaller sum to pay a developer to code their app, or to rent an industrial unit for their packaging operation. While a huge Series A might grab the headlines, the requirements of a startup are better served by the very things which often make high-growth companies so successful – flexibility, dynamism, the ability to react and adapt to an ever-shifting ecosystem.
That’s where the model of continuous funding comes in – and why, in future, the very idea of a funding round will likely seem out of date.
In the past, raising a round meant raising from your various investors all at once. That meant bringing them all together to negotiate endless individual sets of legal documentation, with the goal of reaching a pre-determined figure based on what you think you might need.
With continuous funding, you can meet investors on your terms – at a trade show, industry event, even a party – and at a time that suits you – at 8pm on a Wednesday night, or 2am on a Sunday morning. Instead of turning investors away until your next big funding round, you can make plans for them to invest whenever and wherever the both of you are.
How is this possible? The answer, as with many things in the world of startups, is technology. Funding automation technology not only produces the shareholder agreements and other deal documentation that most founders know they need, but it can also give them access to the funding they want much more efficiently.
This happens through a few processes. The first is by enabling founders to negotiate advanced subscription agreements with shareholders – what we at SeedLegals call a SeedFAST agreement – meaning essentially that founders get funding ahead of a formal round while agreeing to offer shares to an investor further down the line.
The second is by giving access to what we call Instant Investment – the ability to top-up a round at any time – which has given rise to what’s known as a rolling close round. Developments in funding automation technology mean that not only can you negotiate these agreements with investors wherever you both happen to be, but you can generate the necessary documentation without the involvement of costly lawyers – particularly useful given the increased frequency of smaller individual funding agreements that founders negotiate in the model of continuous funding.
But perhaps the real reason why the formal round will one day become a thing of the past is that new methods increasingly make sense for investors too. Investing in companies is traditionally seen as a gamble, with the small likelihood of a single investment becoming a success offset by the prospect of huge returns.
If you’re a sizeable fund, this may be a gamble you’re willing and able to take, but if you’re one of the growing numbers of angel investors in the funding ecosystem, this high-risk approach aligns far less with your interests. The smaller, more frequent raises of continuous funding mean that angels – who are necessarily required to be more discerning with their capital – can also mitigate the pressures that come with high-volume rounds.
These new models of fundraising are transforming the way UK startups are building and growing their businesses. At SeedLegals, we’ve observed that over half of all companies who are fundraising are enabling rolling close rounds, making use of innovative funding methods which empower them to continuously raise capital without shifting focus from their core business activities.
It’s a trend which doesn’t look like slowing down – indeed, the signs are increasingly pointing towards the dawn of continuous funding as the normative model of investment in the UK’s blossoming startup ecosystem.