A Guide to Micro Seed Funding

 

Advantage: Ability to Sell Early

Investment in startups is a high risk business.  Seed funders, angels, and venture capitalists have a strategy to minimize this risk by investing in a range of different companies.  The vast majority will fail, but a few might return 20 or 30 times the initial investment amount, which can more than make up for the losses.  One can see that the odds of a successful exit are stacked against the entrepreneur.  

Most investors want to receive a minimum level of return during a liquidation event.  Ron Conway, a prominent angel investor, has stated that he’s satisfied with a 10x return.  A 3x return is not nearly as appealing because it barely covers the time and effort to assist the company, and it also does little to cover the losses in other companies.  To protect against premature sales that might be only be appealing to the entrepreneurs, many investors will enforce minimum selling levels either through board control or terms in the definitive agreements.

Ron Conway discusses these and other important considerations in this video:
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Raising $15,000 to $20,000 from Y Combinator for a 6% - 8% equity stake implies a post-money valuation of around $270,000.  This valuation allows for a wide range of exit opportunities for the founders and they still have a large majority of their ownership intact.  Even given a 10x return, any exit greater than $2.7 million is appealing to all involved.  Y Combinator states on its website, "if you want to sell early, that's ok. We'd make more if you went for an IPO, but we're not going to force anyone to do anything they don't want to."  This is advantageous for the entrepreneur because a multi million dollar angel or venture capital round can severely limit the exit opportunities.

For example, during 2006, the median pre-money valuation and amount raised for companies completing a Series A round was $6 million and $4 million respectively. [1]  Thus on average, the post-money valuation was $10 million (post-money val = pre-money val + amount raised).  In this scenario, an exit above $100 million dollar (10 x $10mm) would satisfy the investors.  However, as can be seen by the chart below, acquisitions under $100 million are quite common.  While a $50 million dollar acquisition offer would be financially exciting for the entrepreneurs, they would be unable to sell at this price because investors require a better return.  For more information on this topic, check out the following websites: 1, 2, 3,4.


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NOTES:
[1] http://www.startupcompanylawyer.com