Fundraising in the Nordics: Getting a fair first deal
The Nordic ecosystem is seeing a surge in founders with a long term mentality for building sustainable businesses. As investors, we need to catch up and provide a fundraising landscape in which we truly serve these founders as our customers and partners.
When an investor pushes for 30–40% of your company upfront, rest assured that this is not the dynamic they have in mind.
Saying no to money can feel confounding when you’re first fundraising for your startup, almost like pulling the rug from underneath your own feet. However, in the long run this dilemma can feel like a walk in the park compared to taking money from the wrong people or at one-sided terms.
When a company’s cap table has been thrown off balance from day one, it becomes quite a headache to clean it up and raise follow-on funding. Additionally, you risk putting all your eggs in one basket by giving too much control to a potentially unaligned shareholder.
Let’s try to dig in and lay out some of the situations in which one-sided deals have been common, and how founders can navigate these situations in the future.
1. Contradicting long-term incentives
The most common scenario leading to an unaligned cap table after the first capital injection, is often when founders and investors have diverging long term incentives. After months of bootstrapping and building your first MVP, getting substantial interest from people with deep pockets can be alluring. This is when rushing into a deal can become tempting.
In this situation, a stoic mindset is your greatest asset. Don’t let the promise of a quick deal rush your decision making. Take your time and conduct your due diligence on the potential investor and gauge their long-term conviction in your company. Learning the tips and tricks for negotiating with first-money investors can be an asset in this scenario. More on that topic here.
From the perspective of a potential investor who has little to no experience with startups, it may feel absurd to bet on a company with no revenues or no product in the market, so why should she / he only get 5% for a $100K check? Why not 20 or 30%?
Owning a bigger piece of the pie may feel like risk mitigation to some investors, but in reality hogging up excessive space on the cap table will only make it harder to raise later-stage fundraising, and may jeopardize long term incentives of the founders.
However, it may be that your new investor thinks only one round of financing is necessary to take your company to product-market fit and beyond. This may suffice for a traditional small business, but this is not realistic for a high growth venture scale company.
When negotiating with your first investor, using concrete examples from KPIs and budgets needed to hit milestones can serve as leverage to communicate your specific ambitions. Highlighting the necessity of follow-on fundraising to get to subsequent milestones is an essential starting point to aligning investors with these interests.
Educating both founders and investors on long-term orientation is at the core of this. When your investor doesn’t have conviction in you and your company for the long term, the default is to optimize for the short term. This is when company-killing deals are made.
2. Disproportionate liquidation preferences
Liquidation preferences have been a hot topic of discussion in the past and can fundamentally change the founders’ outcome, especially in scenarios with down rounds or relatively small exits. Historically, Nordic investors have seen minimal competition for most early stage deals, which is usually the perfect breeding ground for pushing unfair liquidation preferences.
From an investor’s perspective, it may feel beneficial to have a participating liquidation preference with a relatively high multiple for downside protection, as this can theoretically lead to a return even if the company valuation doesn’t increase much.
The irony here is that investors will make their money from placing bets on the most competitive companies, not from the nitty gritty of contracts. The ideal liquidation preference would be a 1x non-participating, which protects the interests of investors while ensuring long term alignment with founder incentives. Even if an aggressive liquidation preference comes with a high valuation upfront, it will set the precedent for later stage rounds, and ultimately does nothing more than discourage founders from building and growing a sustainable business for the long term.
3. An antiquated view on dilution
Another motive for pushing one sided terms may be due to a distorted attitude towards dilution. Dilution is often seen as a threat to financial returns, especially when taking pro rata is not an option. However, in reality new funding rounds are accretive and not dilutive.
For the sake of argument, let’s say you as an angel invested $150K for 5% in a pre-seed round with a $3M post money valuation. If the company then goes on to raise a round of $1M at $6M pre money, you’d now own only ~4% but doubled your investment. Why focus on the incremental percentage reductions instead of the value appreciation of your invested capital? For an angel investor who doesn’t have to adhere to the same fund economics as VCs, this is simply short sighted.
As an investor, focus on maximizing your upside (by establishing genuine relationships with top founders and investing in them) rather than protecting your down side.
While there is often conflicting advice on whether to raise from VCs early on, adding an experienced institutional investor in the first “official” round can have value beyond the check. While this will inevitably dilute first-money angels, having someone on board who can send a strong signal to later-stage investors or even follow-on themselves, will undoubtedly increase the likelihood of long term success. Incremental drops in ownership percentages become irrelevant at this point.
However, as a caveat, it is vital that you as a founder also help to protect the interest of amicable first-money angels when bringing on a new VC. It’s not uncommon to hear of angels being squeezed out of follow-on rounds by funds with rigid ownership targets. Roger Ehrenberg shares a detailed anecdotal experience of this here.
Luckily, we are seeing an increasing number of founder-focused VCs here in the Nordics who are used to collaborating well with angels, are willing to invest in the pre-seed stages and have the capacity to follow-on at the later stages.
Let’s wrap up with the actionable insights a founder can apply to ensure a fair first deal:
- Do your homework on any investors who offers you a deal. Don’t rush into anything and ask around about the investor before moving forward.
- Don’t give up more than ~25% of your company in the first round. You’ll want to weed out investors who are clearly not on-board for the long term. Asking for an excessive percentage of your company is a clear red flag on this front. Fear of dilution is not a valid excuse to clog up your cap table.
- Clearly communicate your long term ambitions and why you’ll want to raise follow-on funding. One round of funding is usually unrealistic for a high growth startup. Communicate this to your new investor via data and KPIs if they’re not getting it.
- Don’t accept aggressive liquidation preferences. The optimal term is a 1x non-participating. Even if you’re offered a 2x higher valuation but with a 3x participating liquidation preference, even a decent exit can leave you empty handed.
Hopefully this will bring a little more light to these issues. Of course there can be other variables leading to potentially one-sided deals (for both founders and investors), which we’ll continue to explore in future posts. Educating both founders and investors on fair deal terms is vital to leveraging our progress, and evolving our ecosystem to compete on a global level.
Special thanks to Neil S W Murray for feedback on this post.
Futuristic is an early-stage VC firm based in Copenhagen, investing all over the Nordics. We invest in beautiful minds building epic companies.
You are always welcome to reach out with comments or feedback at daniel@futuristic.vc
