Surviving the Series A Crunch: Financing Alternatives

The “Series A Crunch” is the inability of startup companies to raise a second round of equity financing (a “Series A”) after completing their Seed round. Many startups who are unable to complete a second round will be forced to shut down. Founders who are struggling to raise equity financing should remember that there are some alternatives that don’t involve continued bootstrapping and/or personal debt. 

Angel Syndicates 

Consider accepting smaller investments from a large number of investors in the form of a self-created syndicate of angel investors, family members and friends, many of whom invest only $25,000 or $50,000. While raising a seed round or Series A round like this may require a significant amount of time, effort and angst from a founder, it can be effective and often leaves the founder with greater control over the company than if the funds had been raised in a round led by an institutional venture capital investor (or a smaller group of “super” angel investors), who would usually insist on a board seat and protective covenants in the company’s certificate of incorporation as a condition to their investment. 

SAFEs and Notes 

Also consider alternatives to the usual preferred stock in the form of SAFE or convertible and non-convertible note offerings. Read more about SAFEs here, and Convertible Notes here. As for non-convertible note offerings, some investors prefer to invest in debt rather than equity, so you may find new sources of funding by offering to sell regular, nonconvertible promissory notes. You can be creative with the payment terms in these notes. For example, an investor’s return could be interest, a fixed multiple of the loan amount or a capped revenue share from a new product. Bear in mind that promissory notes sold in a note offering will be restricted securities, even if they are not convertible into equity, so you should consult with an attorney before doing a note offering, and you must limit the offering to accredited investors. 

Venture Debt 

There are also a variety of venture lenders who cater to startups, especially those that have some revenue. Venture lenders offer loans varying between 20% – 35% of the most recent equity round and may allow repayment over time out of the company’s revenues, rather than on a fixed payment schedule. The interest rate or structured return on these loans may be as high as 6 – 10% in some cases; however, if you are confident that your business will be significantly more valuable in the future, then this sort of debt financing could end up being much cheaper than equity. Read more about Venture Debt here. 

How to Prepare for an Equity Financing

We have covered in past FTTWs how to value your startup and how much capital to raise. Once your startup decides to pursue equity financing, you should start to prepare for the investor due diligence process. On the business side, you will need to prepare a business plan and should take steps such as obtaining management references, interviews and background reviews, customer/user references, technical/product reviews, financial statements and business model reviews.

What Every Startup Needs to Know

On Wednesday, June 26th, Perkins Coie’s Palo Alto office hosted the startupPerColator event, “What Every Startup Needs to Know.” Lowell Ness, a Perkins Coie partner in the Emerging Companies & Venture Capital (ECVC) practice, moderated a panel which included Herb Stephens of NueHealth, Thomas Huot of VantagePoint Capital, Jennifer Jones of Jennifer Jones and Partners, Yuri Rabinovich of Start-up Monthly, and Olga Rodstein of Shutterfly.