How About That 'B' Round? If it's time for a second round of financing, read this first.
By David Newton
Opinions expressed by Entrepreneur contributors are their own.
When you launched your firm with equity capital, you sold shares to the original investors at a set price, issued the common stock certificates, the money transferred into the company account, and off you went spending the funds on the items disclosed previously in your business plan. Life was good. People were hired, equipment was purchased, leases were signed, contracts were executed, and handshake agreements finally had cash to back them up.
Waiting for revenue to come in to your firm, at a level sufficient to cover your regular monthly operating expenses, can be frustrating in the early going. The bills are still there every week, but the sales dollars are still inconsistent (or in the case of many new launches, nonexistent). You know your venture is ready to turn the corner and close on a few solid revenue deals, but you're not quite ready to dig too deeply into the company's line of credit until there is a clear path to reliable cash flow coming into the firm.
Raising another round of equity capital is probably not all that exciting of a project at this point, but it often turns out to be a necessary endeavor given the open-ended nature of nailing down when regular sales will start to happen. Your initial funding deal is your "A" round, often called the seed round or the "launch capital." Too often, entrepreneurs believe there is some kind of shame in asking for money in a subsequent round of funding, because they're afraid that it appears they didn't do a very good job budgeting the initial capital raised. But that's simply not the case.
Many things in running a business turn out to be more expensive than originally planned for. Salaries and benefits are often higher than the figures quoted when the budget was constructed. And sales don't always come strolling into the company's "in-box" at the pace projected in the business plan. Raising additional capital through a "B" round is a very normal process in venture development. But there are good ways to go about it, and awkward ways to try and make it happen.
Let's start with the favorable scenarios. Pitching your venture to investors in a "B" round can be a very positive experience for the entrepreneur and the capital providers. If you have a solid track record of benchmarks achieved; personnel successfully recruited, hired and trained; partnerships put in place; and customers in the sales pipeline, then the venture is right on track with its targets. It simply might be that these haven't happened in the exact same time frame originally envisioned.
If you have a tight paper trail summarizing your strategies employed, board meetings, contracts in place, employees and projects completed and still in process, investors will generally view that next round of funding as a favorable time to get into the firm, because so many items that were once all outstanding and pending are now finished and in place. The risk of investing in a "B" can actually be viewed as lower than the "A" round, if the entrepreneur does a great job of documenting the forward progress of the organization.
But if the investors have little to go on in the way of tangible evidence that you've done a great job in moving the venture forward, asking for another round of cash could easily be interpreted as giving money to someone who doesn't have a solid plan for success. When you come asking for equity capital without a clear demonstration that you're competent to lead this enterprise, investors' confidence in you is greatly diminished. But when you come asking for a second round (or later a third round, "C") and investors see that you're well on your way to making this business a solid reality in the market, and it's just a matter of timing on some very promising deals, they will be much more receptive to your pitch.
And remember, your "A" round investors probably have a preemptive right in their stock agreement to maintain their relative percentage equity stake in the firm when the company issues subsequent shares, so you'll need to approach them first to see if they have interest in backing you with some more cash. If you have your company's house in order, "A" round investors often have a strong interest in being capital providers for the following rounds, and why not--they know you and your work. And be aware that some of them may want to "pass" on their preemptive right (for various reasons not involving you), and that's OK. But be sure they don't opt out of the next round because of their lack of confidence in your ability to run a tight ship.
David Newton is a professor of entrepreneurial finance and head of the entrepreneurship program, which he founded in 1990, at Westmont College in Santa Barbara, California. The author of four books on both entrepreneurship and finance investments, David was formerly a contributing editor on growth capital for Industry Week Growing Companies magazine and has contributed to such publications as Entrepreneur, Your Money, Success, Red Herring, Business Week, Inc. and Solutions. He's also consulted to nearly 100 emerging, fast-growth entrepreneurial ventures since 1984.
The opinions expressed in this column are those of the author, not of Entrepreneur.com. All answers are intended to be general in nature, without regard to specific geographical areas or circumstances, and should only be relied upon after consulting an appropriate expert, such as an attorney or accountant.
