25% = Round A: Latest cost of capital from VCs

I am often asked “What will the first round of VC money cost me? So today I’ll share what I have found during a recent campaign for a couple of startups.

In a nutshell, “A Rounds from respected VCs will cost you about 25% of your company.” There is typically a range around that 25% of plus or minus 5%. And the 25% can become 50% to 60% in some cases. VC’s do not all price their money the same way as their competitors.

Are you confused? Well let’s help you get unconfused.

1. The      first round of cash from outside investors is named the Seed Round. For a      Bootstrap startup, it comes from your personal bank account. For classical      new enterprises, it can come from a motley crew, from various sources.      Often they are supplied by angels (wealthy individuals) or the infamous      FFF: Family Friends and Fools. Some top tier VC firms do Seed Rounds, but      they are in the minority.
2. Seed      Rounds are typically less than $2 million, most often in the range $0.5 to      $1.5 million.
3. The “A      Round” can be the first round of capital from investors. Then it is      referred to as the “Seed Round.” But the Seed Round can be followed by an      A Round. So first get the definitions of your rounds straight. And then      decide on what you are looking for.
4. Half the      VCs I have spoken to during September to December, 2006 have said their      typical A Round will cost the company close to 25 percent of the company’s      shares. In VC language, the post-money ownership ends up with a quarter of      the shares owned by the investors.
5. The A      Round is typically used to finance the construction of the first product.      The Seed Round is typically used to complete a detailed business plan that      includes how to build the first product.
6. The      size of the A Round is most often around $3 million, give or take a      million or two. If your bplan calls for more than that to finish your      first product, you will have to do that with a B Round. That is a tricky round      to close on if your first product is on schedule (rarely) but not      completed (half pregnant).
7. The B      Round is typically double the size of the A Round. Unless you ran into      trouble and need the B Round because you ran out of money. Then the rough      times start and you know why venture capitalists are notoriously dubbed      vulture capitalists (a term I think is not appropriately applied to the      good VCs).
8. The B      Round is typically priced per share at double or more the price of the A      Round. If you are able to succeed with spectacular results (finished      critical hiring, building the product and securing some great customers)      as cash from the A Round nears its end, you can look to increase in the prices      for your B Round shares by a lot more than doubling them.
9. Be      careful to think and plan your first three rounds of financing. For      instance, I have been told recently of several in the $100 million amounts      that followed typical A Rounds that had cost the company around half their      company for the large ($6 - $10 million) A Round.
10. To      plan your rounds of financing (pricing them), the secret trick it to work      backward. Start at the IPO and work back, year by year, to the Seed Round.
        

That’s a quick introduction. I hope it helped you. More can be found in my books, including details about share for employees (options).

BOTTOM LINE: Find help when pricing your rounds of capital. Ask other CEOs. Find a great lawyer. CPAs can be helpful. And simply ask the VCs in advance: they will tell you what they expect in the kind of round you are looking for. They know that the VC money is competing intensely for good deals (like yours) and that other VCs know what the going market is (valuations of companies) for venture capital. If you get the pricing of your rounds planned and executed well, you’ll have enough to go around for everyone you need to be a winner. That can be a powerful addition to your unfair advantage.

Comments

[John]

Anthony is one of many who prompted me to write the second book, The Power of Unfair Advantage and to add to QuickUp the practical "how-to" example of how to price a real round of venture capital. TX for your comment, Anthony!

[Anthony Sanichara]

I bought the book "High Tech Startup". For the most part, the book is of little value to an entrepreneur looking for some real practical help.

I was really disappointed though with chapter 9, particularly with the topic of pricing the next round. John has a nice table on page 182 with lengthy explanations on the following 2-3 pages on what you "should" do in pricing the next round(s). It would have been so much more effective if he could have simply worked through the example to show "how" to do the pricing. There are many generalities that just left me hanging.

I even looked at the web site to see if I could get a bit more. No luck. He has the same: the trick is to work backwards. Start at the IPO date...

Why not explain the trick? Anyway, if I had to recommend this book, I would say no.

[Jay Liew]

John,

Thanks for sharing this, I've learned a great deal about this since I have a mostly tech background and not much business experience! Reading your post reminds me about the importance of relationships, in business.

Cheers,

Jay

[Brendan Monaghan]

John,

Great piece. So many people are into the tech space and reading about the latest and greatest companies, what products they've built, etc. but few understand all the financing behind the product.

Thanks for sharing your insights.