Staged Financing Flashcards
Why does staged financing appeal to entrepreneurs and investors?
For investors:
Reduces the amount of money at risk.
It gives the option to re-invest conditionally on the performance of the venture.
Entrepreneurs:
Lowers the cost of capital and improves the company’s valuation.
It reduces dilution (if the price per share in subsequent rounds increases)
Downside: requires multiple negotiations, costly for both parties.
What is the Option Value of Staging?
The value that the investor gets from the option of abandoning the project.
Dividing the project in stages, and in probability of success @ each stage, the Expected discounted valuation will be higher as there are more stages because the probabilities of success are accounted for singularly at each round. Instead of multiplying them all together giving a probability of success in one go of 10%.
What is Tranching?
Tranching is when the Investment amount is defined upfront, but the capital is released upon reaching of predetermined milestones.
Pros: Preserves option value for investor, no extra negotiation costs per each stage.
Cons: No reduced dilution for entrepreneurs because the price is negotiated only once at the beginning.
Often at different stages there are different investors. How does an investor preserve its ownership?
Dynamic Games, old investors will not waste bargaining chips on things later investors will change.
Investing “pro-rata”, hence retaining the same ownership fraction as the previous round. Equilibrium point where investors don’t care about the next valuation and don’t worry about dilution.
Insider round = round financed by old investors
Outsider round = round financed by new investors
“Retention rate” = ownership fraction new round / ownership fraction last round
it’s a measure of dilution
How does liquidation happen with subsequent investors?
Different series investors often have different terms. Usually series B investors have a higher seniority that series A. Meaning that they they get the liquidation money before the others.
“pari passu” means that they have the same priority ranking.
What happens in case of a down round?
Price per share is lower than in previous round.
Anti-dilution rights are used by earlier stage investors to prevent dilution in case of a “down” round.
- “full ratchet” clause
- Weighted average formula (broad band/narrow
band)
Stock options might be “under water”, worth less than their strike price.
What are turnarounds?
Turnarounds are rounds when a company that is performing poorly but still has some valuable assets that can be re-organised and used in a different market, gets finances.
In this rounds, the company is worth a fraction of its starting value. So turnaround investors get the majority of the company.
Lawsuits if the turnaround is successful.
