How Late-Stage Companies Can Assign Capital Purpose

The Art of Assigning Capital a Purpose

Early stage companies typically want capital for concrete reasons, knowing that their success could ride on whether or not they get investment. They could just be starting out with product development, building a team of employees or formalizing customer acquisition strategies.

On the other hand, the purpose of later-stage Series C funding can sometimes be vague, and companies often use the broad statement: “We’re using the funding to undergo significant expansion and scale successfully.” But what does that really mean? And is it sustainable? Sometimes it isn’t.

Take the example of Adero, a US-based tracking device developer, who in 2018 raised its series C round at a massively reduced valuation, according to PitchBook. They then randomly pivoted from making tracking device hardware to building software while laying off 45% of their staff. However, the pivot didn’t work, and the company shut down in 2021.

This is the issue with Series C: If a company’s goals are not realistic or achievable, they may end up wasting resources, failing to meet objectives and getting a poor return for investors. This can damage investor confidence, making it more challenging to raise additional funding in the future and limiting the company’s ability to continue scaling operations.

It is time to think more specifically. Are you aiming to expand your company’s workforce, invest in research and development to enhance existing products, or open new offices to expand into new geographic markets? Perhaps you need to hire three salespeople, invest in ongoing marketing campaigns or develop a new eCommerce sales channel. Whatever it is, nail it down.

At Series C, companies also have additional elements to consider compared to previous rounds, such as preparing the company to be acquired or go public on the stock market (although businesses should have exit strategies sorted from the get-go).

And the icing on the cake? Having a set purpose means it’s easier to identify potential issues associated with each objective and develop a plan to mitigate those risks.

Choose the Right Late-Stage Investors

Purpose doesn’t just refer to company objectives; investor goals must also align.

Many investors from previous financing rounds, like venture capital investment firms and angel investors, also tend to participate in Series C financing. But this round, often associated with lower risk, attracts new players and large financial institutions such as investment banks and hedge funds. Therefore, as a later-stage company, you will have a broader set of investors to choose from than in the early days. The full list is as follows:

• Traditional Venture Capital (VC)
• Hedge Funds
• Private Equity Funds
• Family Offices
• Special Purpose Vehicles (SPVs)
• Public Market Investors
• Strategic Investors
• Large Foreign Internet Companies
• Sovereign Wealth Funds

Note that companies at the later stages of development generally have higher valuations since they are established and relatively successful. So, potential new investors will likely pay high prices for the company’s shares. But before you get too overexcited and dive into a funding deal, assess the following:

1. Can the investor follow you to other rounds or an IPO?

Let’s take a look at the company Unity Technologies, a video game software development company. They’ve had an investor that has stuck with them through thick and thin: Sequoia Capital. This prominent venture capital firm — known for funding Airbnb and Dropbox — supported Unity in its Series C funding round, Series D funding in 2018, and initial public offering (IPO) in 2020. They helped Unity make decisions from moving from a paid to a freemium version and from a perpetual license fee to a recurring, subscription-based model. So, if you can find an investor to commit long-term to your company, here’s a living example of the successes it can reap.

2. What is the investor’s strategic value?

Every investor has their perks. The two most prominent are public market investors with a significant source of trusted capital and foreign internet companies that can quickly help you enter new markets — like the tech industry in China.

Then, traditional VCs could provide operating or scaling advice, while hedge funds may better understand your industry based on their investments in public companies.

Then, thinking further to the future, strategic investors wanting to accelerate your business growth often invest as a prelude to an acquisition offer. And angel investors already on your cap table may raise money for you as part of a large venture round to increase ownership in your company — with permission.

3. How complex are the terms?

Deal terms at Series C are likely complex, so you’ll need to work with an experienced lawyer. You and your investors must agree about pre-money and post-money valuations in your term sheet.

Watch out for the two most important terms: pre-emption rights and preference shares. Pre-emption rights allow existing investors to buy additional shares before making them available to new investors. This is because shareholders are diluted at every funding round as shares are issued to new investors, reducing their overall shareholding percentage.

The second term is as opposed to ordinary shares. Preference shares come with liquidation preferences and anti-dilution, meaning investors get their money back first when there’s an exit sale.

4. Does the investor want a seat on the board?

When negotiating funding deal terms, investors often ask for a board seat. Founders then need to decide whether to say yes after analyzing the value they’d bring and if their goals align.

Traditional VCs are most likely to ask for a board seat as they have a duty of care over investors’ money. Hedge funds, on the other hand, may care less about that, which can be good if you already have multiple board members.

As a way out of offering a full board seat, you could give investors board observer roles; they’d be informal members of the board and able to attend meetings but wouldn’t have the right to vote.

Define Why You Want To Go Public

As mentioned above, if you are keen on going public, that should be clear in Series C. But be aware: The reason or purpose behind an IPO has been changing over the last few years. Instead of startups going public to grow, more are opting for this route because they peak and investors want out.

At one point, startups considered IPOs a rite of passage, providing funding when they were not profitable and transparent to investors and business partners. This was also because only public markets in the past could provide startups with the funding they needed.

Now, private sources of capital can deliver hundreds of millions for startups, letting companies go to public markets when fully valued. Therefore, IPOs are no longer a way to show a company’s legitimacy and fuel development; it’s a way for private investors and employees who have financed companies to cash out for maximum gains.

Remember: Any stage of funding brings risks, roadblocks and uncertainty, but especially Series C with larger valuations and amounts of funding. Ambitious companies need a partner to shield them — and we’re the insurance broker that can help.

Want to know more about Series C funding? Talk to us! Contact us at info@foundershield.com or create an account to get started on a quote.