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Tranched Investments Are Bad For You

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I’ve heard a few people talking recently about taking larger sums of money – lets say $3m – from an equity investor where the investor is proposing to tranche the investment (or where the entrepreneur thinks they might). Typically that means meeting certain milestones to trigger the next chunk of cash. I hate this idea. Why?

  • Well, first of all the investor can be sending you a negative message about their confidence in you and your ability to execute by holding the money. And its distracting to everyone – you should be working with your investors closely anyway to get the right things to happen in the business and that’s the real objective.
  • Secondly, things change rapidly in the startup business and you need to change with them – so a milestone set today to be achieved in six months may be obsolete in three months because of some external event. Then what? Keep driving for it so you get the money? I don’t think so.
  • Thirdly, a VC could decide at any time not to put the additional money in. Lets say they committed the tranches before the recent market crash. Then with the crash their outlook has changed and investment plans rethought. Now they say they won’t put in the next tranche even though you hit the milestones. Maybe they want to renegotiate the valuation down due to those external events. What do you do? Sue them? Again, I don’t think so. Suing investors is never a good idea if you want to raise money in the Valley again.
  • Worst of all, what’s really happening is that the achievement of these milestones is in fact increasing the value of the company each time, but your investor’s equity is all valued at the historical date when you signed the term sheet. So you just took more dilution than you would have if you took two smaller rounds of funding – one at the beginning and one new one later after achieving the growth.

What do you do instead? Well, you bite the bullet and take less now and plan on doing another, separate, raise later. With that $3m example above, take $1m or $1.5m now and raise more at a (hopefully) higher valuation in a year.

Back in March I wrote in a post that I didn’t think financing a startup with debt rather than equity makes any sense unless its to bridge to an equity event you have a high confidence level will happen. Otherwise you just build a pier to deeper water.

In general I stick by that. But there is an exception (every rule needs one!) that I support. In a very early stage startup it can make sense to take initial money, perhaps $300k, from an investor in the form of a convertible note instead of equity at that time. A convertible note is a loan from an investor that is intended to get you going and to bridge to a later equity funding event. As part of the terms the investor can convert the note to equity at a discount, maybe 20%, to the subsequent round preferred stock price. Fair enough – they took the risk now to invest at that later valuation so they should get that break.

When would you do this? Typically, where you need some cash in to get to some proof point or milestone to then get a full equity round done. Your investor likes you and your ideas, but you have no customer traction yet although you’re going into beta with a few prospects. You need six months to complete that process and covert the betas into paying, reference accounts. That is a big step because it gives your first real proof points of your value proposition – and makes you more fundable.

In this case maybe the $300k is sufficient to get you to a $1.8m equity raise (including the note converting) in a full funding round later at a $3m pre-money valuation. That’s better than taking a $300k equity raise now at a $1.2m valuation and then another $1.5m at a $3m valuation later. A convertible note helps do that with less dilution. One other thing – it avoids the need to address valuation questions today. The company will be valued at the time you get a term sheet for the future round in six months. Its much harder to do two equity rounds six months apart and justify an good increase in valuation over that time. So delay that discussion with a convertible note! An investor will like it because it gives them more protection than equity, it’s a smaller amount to risk initially, but gets you going and maybe proves their confidence in the overall opportunity.Of course, if you don’t achieve your goal you will owe the money back – but with no ability to pay it off it will become another negotiation anyway.

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About the Author

This article was written by Philip Smith. Philip is an experienced business professional ready to provide advice, guidance, counsel and hands-on assistance to early stage technology companies to develop, grow and manage their businesses worldwide. He shares his thoughts on Silicon Valley Frontlines, a blog dedicated to entrepreneurship insights.

Callum Connects

Denise Morris Kipnis, Founder & Principal of ChangeFlow Consulting

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Denise Mossis Kipnis’ curiosity in people and the world, lead her to set up ChangeFlow Consulting.

What’s your story?
I’m driven by curiosity. Having been the only one in a room who looks like me for most of my life, I developed a curiosity about who stays, who leaves and who thrives in minority/majority situations including when and how connection and collaboration happen. I was a systems thinker long before I knew what that was, always asking why and so what; and seeing the pieces, the whole, and the places in between. So helping people and organisations move through the complexity of transformation feels natural to me.

What excites you most about your industry?
I see change and inclusion as two sides of the same thing; I don’t practice one without the other. Some people see change as death, as loss, as exhausting. And it can be. But I see in the work I do as an opportunity for something new or hidden to emerge. When an organisation understands that it is first a group of people, who themselves represent and belong to groups of people, and it begins to tackle what it would mean to understand and learn from all that talent, all that diversity, to have them all working for and not against the organisation, to truly unleash all that their people have to offer; that’s magic.

What’s your connection to Asia?
Change and inclusion are personal values as well as professional strengths. For me, living and working outside of the States was a bold experiment to see whether any of the stuff I’d learned about change and inclusion would work outside of the US. My husband and I targeted Asia specifically: it would be the greatest contrast, culturally speaking, for me; and a unique career springboard for him.

Favourite city in Asia for business and why?
Although I’ve practiced in other cities, I am biased towards Singapore. In some ways it’s what Los Angeles is to the rest of the United States, a microcosm of sorts. The regional/global nature of it means that so many different nationalities and cultures are represented. As a result of this mix, you never know what you might get. In some situations, cultural dynamics are obvious, sometimes subdued. The variability is compelling.

What’s the best piece of advice you ever received?
“Never ask anyone to do anything you wouldn’t do yourself.” Michael Rouan.

Who inspires you?
Often it’s a “what” not a “who.” I can get inspiration from a passage in a book or a situation in a movie, as well as a turn of a phrase or watching people interact. I often make the biggest connections between the various threads I’m working on when I’m sitting in someone else’s event.

What have you just learnt recently that blew you away?
I’m honestly not blown away by much. Instead, I’m struck how circular things can be: ideas often come back around with a slightly different twist and I watch the way it shakes things loose for people. I recently sat through a workshop on Self as Instrument, and despite being thoroughly versed already, I learned something. In preparing for a panel on design thinking, I unearthed a new language to describe things.

If you had your time again, what would you do differently?
You’ve caught me at a good time. I’m sitting in appreciation and gratitude for all my experiences, because I wouldn’t be who I was today if all that has happened, didn’t. And yet one thing comes to mind: It wasn’t until I redesigned my website two years ago (shout out to Brew Creative!) that I realised I hadn’t made explicit agreements with my past clients as to what I could share publicly about our engagement, or whether I could use their logos in my promotional materials. In my business, confidentiality is so important, and yet I need to be able to talk about the work as reputation and experience leads to the next success, and so on. It turned out a lot of the contacts I had known had left the organisations where the work was done, so they couldn’t help at that point. So the practice I’m carrying forward is to get those agreements up front, and to make sure my relationships in client systems are broad as well as deep.

How do you unwind?
Science fiction, puzzles, wine.

Favourite Asian destination for relaxation? Why?
Home. I don’t travel to relax, I travel to learn and explore.

Everyone in business should read this book:
Built to Change, by Ed Lawler and Chris Worley. To my knowledge, it’s the first pivot from advising organisations away from stability and toward dynamism, from strategic planning to strategizing as an action verb; to blow up the traditions and rigidity that impede organisations from developing change capability.

Shameless plug for your business:
We’re taught that there are two kinds of people: those who see forests, and those who see trees. There is a third type, my type, and we see the ecosystem. Worms, climate, birds, the spaces in between. This is the perspective organisations need to be successful in solving complex problems and thriving in change.
ChangeFlow uniquely blends four disciplines (two of which are multi-disciplinary in themselves): organisation development, culture and inclusion, change management and project management.

How can people connect with you?
Facebook: https://www.facebook.com/ChangeFlowConsulting/
LinkedIn: https://www.linkedin.com/in/dmorriskipnis/
LinkedIn Company page: https://www.linkedin.com/company/4862954/
Email: [email protected]
Website: http://www.changeflowconsulting.com

Twitter handle?
@ChangeFlow

This interview is part of the ‘Callum Connect’ series of more than 500 interviews

Callum Laing is an entrepreneur and investor based in Singapore. He has previously started, built and sold half a dozen businesses and is now a Partner at Unity-Group Private Equity and Co-Founder of The Marketing Group PLC. He is the author two best selling books ‘Progressive Partnerships’ and ‘Agglomerate’.

Connect with Callum here:
twitter.com/laingcallum
linkedin.com/in/callumlaing
Download free copies of his books here: www.callumlaing.com

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Callum Connects

Agnes Yee, Legal & Compliance Recruiter of Space Executive

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Agnes Yee started Space Executive in Singapore, which is a hub for businesses in some of the world’s fastest growing economies.

What’s your story?
After graduation, I joined a design media company as a Business Development Executive, during the era when ‘reading a magazine online’ was unheard of. I believe that laid the foundation for being unfazed by rejections.

I fell into recruitment pre-GFC and rode the highs and lows in the early years. A decade later, I decided to set up my own recruitment company, partly because I could. I’m acutely aware of the face that being an Asian female in Singapore is sometimes a privilege, and that many women in the world are living a very different existence.
Thereafter, we joined Space Executive as part of a merger. I am currently the Partner of Space Executive, a recruitment company focused specialist disciplines, including Legal, Finance, Digital, Sales and Marketing and Change. We also run Space Ventures, a venture capital business, which invests in seed and pre-series A businesses.

What excites you most about your industry?
On a daily basis, we’re influencing how one spends a third of their day. It is interesting how the Internet has transformed the industry, and I’m excited to see how we can harness technology to bring us to the next phase of this business.

The VC is an extension of applying our skills and experience in reading people. We very much invest in the people as much as the idea. Being a native Singaporean, it’s been exhilarating watching Southeast Asia becoming a hotbed of ideas; and young entrepreneurs simply daring to dream.

What’s your connection to Asia?
I’m a born and bred Singaporean. I love that I speak both English and Mandarin, grew up playing with Indian friends and eating Malay food.

Favourite city in Asia for business and why?
Singapore for the low barriers of entry to set up a business, but has to be China (and Hong Kong) for their hunger and constant innovation.

What’s the best piece of advice you ever received?
青春不要留白 which translates to ‘Don’t waste your youth.’

Who inspires you?
Anyone who has gone against the grain.

What have you just learnt recently that blew you away?
It wasn’t recent but reading the article on https://waitbutwhy.com/2015/12/the-tail-end.html never fails to blow my mind how little time we have left. Charting our lives in weeks, and realising I only have enough time left to enjoy 60 Christmas turkeys, read 300 books (all if I’m lucky); and mostly, I’m left with the last 5% of the time that I spend in-person with my parents.

If you had your time again, what would you do differently?
I’m cognisant that every decision I made in life has brought me to where I am today, and I wouldn’t change one thing. But I’d really like to have had more time to travel.

How do you unwind?
Exercise and wine.

Favourite Asian destination for relaxation? Why?
Trekking any mountain in Asia. It brings us back to the most basic. To overcome elements of nature and our own mind.

Everyone in business should read this book:
Start with Why, Simon Sinek

Shameless plug for your business:
Space Executive started in Singapore, a hub for businesses in some of the world’s fastest growing economies. We assist organisations in accessing a targeted and specialised, and often times transient talent pool.

Out of Singapore, we have recruited across 14 countries; and have embarked on our global expansion plans with offices in Hong Kong and London this year, and US, Japan and Europe in the following years.

Space Ventures provides funding, management and financial guidance to young businesses with original ideas. We have invested in peer to peer lending platforms, credit scoring, social media education, and other start-ups spanning diverse industries. We are always interested in hearing more about new ideas.

How can people connect with you?
https://www.linkedin.com/in/agnesyee/

This interview is part of the ‘Callum Connect’ series of more than 500 interviews

Callum Laing is an entrepreneur and investor based in Singapore. He has previously started, built and sold half a dozen businesses and is now a Partner at Unity-Group Private Equity and Co-Founder of The Marketing Group PLC. He is the author two best selling books ‘Progressive Partnerships’ and ‘Agglomerate’.

Connect with Callum here:
twitter.com/laingcallum
linkedin.com/in/callumlaing
Download free copies of his books here: www.callumlaing.com

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