Two things are popping up more and more in 2021:
1) I get a fair amount of questions about equity and where it should land for first-money-in through the mentoring I do for early stage companies. Unfortunately, it’s not a straightforward answer.
2) Round inflation is real. It really doesn’t matter if you mark your first round as a ‘pre-seed’ round (although, these are starting to seem kind of bogus). It likely doesn’t matter if your first round is sizable and you still call it a Series A.
Tackling the part 1:
It depends on a few factors, but the larger inputs will be on the founders and their previous (if any) companies, the type of company (i.e., commerce, machine learning, investing apps) being built, the location of that company (i.e., Berlin vs. Boston), and the stage the product is at / traction by the time the founder(s) want to bring in capital.
With that said there are some general guidelines that you can follow, which unfortunately are still dependent on the type of deal: a convertible note, SAFE, priced round, etc.
As an example, lets say you want to raise $1M for your seed round. It’s highly likely in today’s market you’d be executing a convertible note or a SAFE. And lets say it comes from a group of angels or a single check that requests it (or perhaps your lawyers advise) a convertible note.
The next step is realizing that there are a few buckets of soon to be equity holders if you convert from the note; you (and your co-founder(s)) will no longer own it all. At this stage, it should generally fall into four categories:
- Investors: your angels
- ESOP: for your key employee(s)
- Options: which could be leveraged for ace advisors who are vital
As a founder, you want to keep as much as humanly possible. As an investor, you want an amount that will not hurt the company, but will provide the necessary upside for you. For the ESOP, you should always put aside the general amount to capture your talent until the ‘up’ for the next round. And for the options, this is a tool you can use for advisors or others yet to be determined. For what in today’s market is labeled ‘pre-seed’, which is angels and family & friends, or even into the non-institutional ‘seed’ round, the below can track as follows:
- Founder(s): a normal range of ownership on the lower end is 70%, while 80% is on the more realistic end.
- Angel(s): a normal range of ownership can be expected between 10-20%.
- ESOP: at this stage of a company 8-10% would be considered a normal range.
- Options: if you deem this strategically needed, a few points will be enough, say 1-2%.
Tackling part 2:
Most of this is simple nomenclature so VCs can box your company’s stage in somewhere. It’s fully understandable that founders need to position their companies as the next big thing. And more than likely, the VC will advise what nomenclature they’d like to use for the round. But the market is seeing large diversions, for example $5M Series A rounds and $60M Series A rounds. Examples like this are where you begin to question if it’s tied to the number of rounds done to date, or the amount of capital being deployed.
It’s quite normal these days to be seeing companies who followed this route:
- Which was once a family and friends round.
- Series A
- Series A+
- Which is likely the company only wanting a 6-12 month runway extension before their Series B. This could be an actual bridge round, it could be because the market will be better in 6 months, or there could be some rationale and change in the market to postpone.
- Series B
- Series B bridge
- Which is likely tied to something coming up where the burn was higher than expected and they need more capital on their balance sheet to achieve the KPIs for either an exit or their next round.
Just whatever you do, please don’t start labeling rounds ‘pre-seed+’ rounds or ‘pre-seed bridge’ rounds!