Unconventional wisdom for startup founders: What not to do in a funding round

Over the years, after advising on various transactions, one thing has become clear to me. As important as it is to seek investments at the right time, and at the right valuation, it is equally important to know what not to sell. In commercial transactions, as in life, it is the ‘undo’ function which is the most difficult to execute and comes at considerable, unrecoverable costs.

Every case, facts and circumstances are different. But how transactions play out in the long and short term do give us some helpful pointers to follow while transacting. So how does one decide what is saleable and what is not?

Sell only what you don’t need to take back

Any equity transaction needs to be understood in this context. When you deal in equity, or for that matter any kind of security of your company in a private placement, it is important to follow this principle – what is once sold, is sold forever.

Founders often spend a lot of energy and focus on the value created (which is how you arrive at the monetary price to be received for the securities). While that is indeed important, and may well be an important part of your sales pitch, what is more important when it comes to structuring your document is this: what you are selling can be further sold, can be converted, and can be bought back too. But just because it can, doesn’t mean it should be bought back.

Buy back should always be a choice, not a need. One can use a philosophical phrase to dramatise this – ‘let go’. Letting go also has a basic business logic. Businesses are built on capital and value. Capital is that what comes in and value is what is perceived outwards. When you sell your securities, you must focus on the value it will create to the investor, not yourself. You must focus not on the value created in-house – but outbound. That, consequently, value will be created in-house is a given.

A lot of times, start-ups have come to us suggesting terms like — we will issue at a higher price now, and take back later. We will transfer more, and take back later if needed. This strategy is counterproductive and never works in the long term. It may not even work in the short term. Transfers and buy backs may sound easy but are fairly complicated processes. Plus, when founders incessantly focus on higher valuations, you can be rest assured that they are giving up something else in return. There’s always a trade-off. And in that trade-off, founders often end up giving what they shouldn’t. They agree to terms that can be punishing for them in the long term.

Know your business, the unknown too

In the start-up world, and more so in emerging markets, knowing what to do and what not to do is not by no means an absolute knowledge. But, it can and should be your business to have and pursue this knowledge. Markets may move in a particular direction, different from what you have planned for your business, but an entrepreneur needs to be so much more tuned in with market movements so that he or she can adapt and finds himself ahead of the curve, at least most of the time.

Staying ahead of the curve and having foresight has several advantages. For one, first movers’ equals’ less capital spent. Second, less funds spent on the wrong turn equals more funds available or spent rightly and better investor sentiment.

Now you may ask what has this got to do with transaction documents, but know this: when you have your ‘use of funds’ clause being discussed and deliberated, it is this what is most useful for your attorney to record correctly. Consequently, this reflects in entrepreneur (promoter) obligations throughout your transaction.

Promise to give as per your worst-case plans, but deliver as per your best-case plans

Many founders have told me that if they share their worst-case plans, they may not attract investment at all. But know this, only that investor is right for you one who is willing to take the risk of the worst case to reap the fruits of the best case. This is the basic difference between an equity and debt transaction. My advice is always this: don’t guarantee returns, but if you have no choice but to, then guarantee that which will happen in the worst case and then make sure that never happens.

While this may sound tough to negotiate, in my experience this has been the easiest to convince. Doing business is always a risk. And investing is always a gamble. Take on board those who understand this math. And those who either understand your business ad trust you or do not understand your business but still trust you. And then run the best sprint ever with their money.

Best investment terms can never be known, surely not through an article or books or a course. Know your business well, read more and enough about the investment world and know that yours will be a new learning all together.

A lot more is required to know when being invested in, but these broad pointers could be your outer boundaries, the canvas then, is yours to paint.

To summarize, that investment is the best investment that helped you give back more than you planned but never took away that which you did not want to give in the first place itself.