Reflections on 12 months in Early Stage Investing.

Our tips and tricks for early stage founders who want as smooth a transaction as possible, no matter the round size…

In 2019, the LUNA team worked across 25+ pre-seed to series B transactions in early stage companies. This saw over $15M invested in Australian startups with the sole purpose of accelerating growth and maximising opportunities. For some founders, this was their first time raising capital. While we worked with both sides of the table (startups and investors), these are our tips and tricks for early stage founders who want as smooth a transaction as possible, no matter the round size…

Forget Percentages — Talk to Pre-money Valuation and $ Invested

As you negotiate key commercial terms with investors, it is important to ensure you are talking the same language. Many founders and investors will frame an investment in terms of the percentage of ownership in the company. The danger here is that the makeup of any investment round is never finalised at term sheet stage. Percentages will change as investors come in and out of the round and commitments change (this will almost always happen).

By getting in the habit of talking in terms of a pre-money valuation (the valuation of your business before any of the invested funds hit your bank account) and an investment amount, both sides have certainty as to what the deal will look like no matter how the state of play changes.

Don’t Skimp on Detail in the Term Sheet

Once you’ve firmed up verbal commitments from investors, it can be tempting to jump straight into drafting the formal transaction documents. However, the most important step in any investment is getting the key terms ironed out in a Term Sheet. Getting all parties on the same page and signed up to the fundamental terms early on will ultimately save a lot of time (and heartache) down the track. We’ve seen people trying to rush this stage thinking it will save time, but trust us — it can really snowball and lead to messy negotiations at a time when you really need the money.

The Right Candidate for your Board

Many early stage founders flinch at the prospect of bringing an investor onto their board. We see time and time again that an engaged and experienced investor director can add amazing value to the management of an early stage company. Often their experience sharpens the operations and governance. Three tips for getting the most out of this situation:

1. Bring someone in with a skillset that fills a gap at board level;

2. Make sure the director is someone who you feel comfortable calling when things aren’t going to plan; and

3. Tap into your investor’s networks to source commercial opportunities, find your next team member and help you close key hires.

Lead Investors are an Asset

Having multiple co-investors in a round typically means that there is more back and forth negotiating the deal. When it comes to settling legal terms, you can save a lot of time and energy by appointing a lead Investor to represent the investor group.

Be strategic when deciding your lead investor. Usually the lead is the investor putting up the biggest cheque but this isn’t always the case. Ultimately, you want the lead to be someone who is available to turn things around quickly and understands how you want to run your business. It can also set up a great working relationship if the lead will be taking a board seat.

Maintaining (Realistic) Momentum

Trying to get the investment over the line requires a delicate balance between maintaining momentum and setting realistic time frames. While you certainly can’t be too demanding of investors, setting clear and reasonable timelines is a great way to keep the process on track.

Once the deal is finalised, having a third party (such as your lawyers) manage the completion process can really take a weight off your shoulders. You can celebrate over a glass of champagne with your investors while others push the paper.

A SAFE Bet

SAFEs have become commonplace in the Australian investment landscape. Most angel investors and VCs with an early stage focus will have no issue coming in under a SAFE. Other more traditional investors have expressed concern and uncertainty (you mean this isn’t a secured loan!). We are all for SAFEs in certain situations. In our view, the perfect time to utilise a SAFE is:

1. for pre-seed funding when you need a reasonably small cheque to scale and prove product market fit; and

2. to get some quick cash in during a bridging round between funding rounds.

Raising multiple rounds on SAFEs (or very big seed rounds) may sting you on conversion if you struggle to hit the next inflection point needed to take your valuation higher. You should also resist the temptation to raise many small cheques from a number of prospective SAFE investors as this makes managing your company that little bit trickier and may come back to haunt you down the track.

A big thanks to everyone we’ve worked with across these deals in 2019. Here are our some of our predictions for 2020:

1. Revenue loans will become far more commonplace in the AUS investing landscape;

2. An influx of angel investors and private wealth will see more funding available for pre-seed and seed stage companies;

3. As the dust settles from poor performing 2019 IPOs (e.g. Uber and WeWork), VCs will turn their attention to sustainable, profitable business models — “zebras” rather than “unicorns”.

4. A trend towards Startup Studios. This model will see investors providing more than just capital in a push to see their startups succeed. This includes financial, strategy and product services as well as training and development.

Authors: Emma Ferguson & Ben Hansky.