Preparing for the Second Round of Startup Funding
By Michael Barnea, Managing Partner at Barnea & Co. law offices
Funding your startup company is an inexact science. The first round of funding helps get your company established, but often leads to a realization that you need more. After the first round, new issues and growing capital requirements emerge and you need to adjust course moving forward. To help you build your company successfully, you should know what the challenges are in each stage you are in, and to be prepared for them.
Challenges Following the First Round
The first round of investment allows you to bring on employees. Following the completion of the first round, your company has shares issued to the founders, to employees through an ESOP, and to the initial investors. The board of directors begins working together with the founders.
This is the point where you begin to discover your ongoing needs and start facing mounting challenges. Money is running out, the available stock option pool is spent, some investors may lose interest and even certain funders may be looking to move on to other ventures or cash out on this one. To allow the company to face these challenges and continue and grow, another round of fundraising quickly becomes necessary.
Plan and Execute the Second Round
When starting down the road to the second financing round, you should have a better sense of what your company is, and should be. This is the opportunity to raise money based on what you have in place. You want to focus on raising the right amount rather than aiming for a specific valuation.
When structuring the second round, you should focus on your current and future capitalization table. The allocation of the shares in your company may distinguish between active and departing founders, must ensure that current and future employees are sufficiently covered, should consider the cash waterfall upon an exit event so that the valuable team is incentivized, and secure the reasonable stake of current and incoming investors.
As part of the second round you should also prepare for a change in the control of your company. It is inevitable that the founders would lose the control of the board that would gravitate towards the investors. This means you should be very careful in selecting the right investors for the second round, as they will have the ability to impact the future of the company, and even have a major role in determining its future direction.
The second round is where you grow from starting a company to building it.