Add-on: Multiple Financing Rounds
This document gives you a brief overview of things to consider when you already know you will face multiple financing rounds.
Of course, not all companies are even looking at multiple rounds of financing. If you have a business model that will generate revenue and profits very early on and just need some initial working capital for the beginning, you might be done in one financing round (or even without one if you rely on bootstrapping, grants or subsidies). Similarly, if you only need money to buy out old investors or owners for the transition to steward-ownership, one round might be enough for you. However, if you need capital to grow and develop your business, it often makes sense to plan for multiple rounds of financing (in steward-ownership-aligned financing and in general).
Instead of raising a large amount of capital upfront (which can often be expensive), some founders choose to raise only what is needed to reach their next critical milestone — ideally with a buffer. This staged approach can reduce the cost of capital in later rounds, as hitting key milestones typically lowers the perceived investment risk. However, it also comes with trade-offs: raising capital in smaller steps may require more frequent fundraising efforts, which can be time- and resource-intensive. Ultimately, it’s up to you to decide what makes the most sense for your specific situation — a decision that often also depends heavily on the nature of your business model.
In steward-ownership-aligned financing, follow-on funding rounds need to be put into relation to earlier financing rounds in terms of returns and preference – that is, who receives more, and who is repaid earlier. So if it is already clear that the company will probably need follow-on funding, a few aspects can already be considered in the first financing round of steward-ownership aligned financing.
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Early communication with your initial investors on the prospect of several financing rounds and their needs and wishes around them can be very helpful to get them on board.
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If you already know that some of the investors will want or need to receive liquidity while you are still raising follow-on funding to grow, the tradability of the used financing instrument can be relevant for you. If the financing instrument (e.g. redeemable non-voting shares or certain contract-based instruments) is tradable, the investors can pass them to other investors. For this to work, creating or using existing secondary markets can be extremely helpful (see for example Sharetribe or Happy Pear).
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Raising funds to buy out old investors can sometimes be a challenging pitch, though this isn’t always the case (e.g. Stapelstein, Haferkater). Investors, particularly ones in steward-ownership-aligned financing, are often wanting to support the development of the company and see the results of their investment, not just create returns for others. So in some cases it might be good to combine growth/development financing with financing of buy-outs in their pitch. Even if the company is already operating under a steward-ownership structure, such buy-outs can still be anticipated and implemented.
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In many cases, earlier financing rounds will be converted into the new financing round in steward-ownership-aligned financing to reduce complexity. So for example if you have used a certain type of mezzanine financing in the first round but are planning for another one or equity in the second round, the instrument and conditions of the first financing round will be converted into the instrument of the new financing round.
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If multiple financing rounds are expected, the choice of financing instrument becomes especially important. Depending on the structure — whether steward-ownership-compatible equity or mezzanine-like instruments — the ability to bring in further capital in a fair and proportionate way can vary significantly in terms of legal and tax complexity. This should be considered early on to ensure that future funding remains both feasible and values-aligned.
For determining the relationship between the conditions of different financing rounds, there can be different logics depending not only on the company’s risk development and the type of investors involved, but also on the specific situation of the company, its anticipated future trajectory, and how many aligned capital providers are available:
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Across multiple financing rounds, terms can be adjusted along two main dimensions: the level of returns and the order of repayment (the so-called “waterfall”). Based on the needs of the company and the profiles of the different investors involved, a coherent and balanced structure can be developed, which is typically negotiated among all parties.
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Earlier investors receive better conditions (e.g. higher returns) and have higher seniority (get paid back earlier), e.g. as recognition for having invested during a higher-risk, earlier phase of the company.
e.g., first-round investors receive a return multiple of 10x, compared to 8x for second-round investors and are prioritized during repayment over second-round investors.
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Earlier investors receive better conditions (e.g. higher returns) but have lower seniority (get paid back later).
e.g. to reward higher risk, first-round investors are granted a 12% return multiple compared to the 8% for later investors, while repayment priority is given to second-round investors, delaying the payout for the first-round investors.
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It is also common practice to structure earlier financing rounds with financing conditions relating to later financing rounds so that no return cap or path to liquidity is determined yet but the conditions of the second financing round with a discount of a percentage X or certain stipulations will apply.
e.g. the conditions of the second financing round will be used, but 25% will be added to the return multiple to account for more risk and the initial investment will be paid back earlier.
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In some cases, the risk actually increases due to the market situation or similar factors – in this case, new investors might receive similar or better conditions than earlier investors. It might also happen that the investment market becomes so challenging that even if earlier investors perceive the current risk as lower, they may need to agree to more favorable terms for new investors to secure additional funding.
Ultimately, the specific terms between new and existing investors, as well as the entrepreneurs (acting as representatives of the company), will need to be carefully negotiated to align with the interests of all parties.