By Brian Halligan, contributor
Times have changed in the growth equity game. It used to be that early-stage venture folks just did early-stage investing, late-stage venture folks just did late stage investing, and public equity investors only invested in publicly traded stocks. What surprised me when raising new funding is that now, it seems like everybody invests in late-stage private companies.
This is certainly not the "official" way to look at it, but here's the way I ended up bucketing types of investors in my own head.
The Surprising Value Of Public Investors Investing In Your Private Company
We went with public funds -- #5 above -- not private funds for three main reasons that made a lot of sense for us, though they might not make sense for your company:
Now, that's HubSpot. Every company is different. Let's just say, as an example, that you are a travel technology company that's doing well, but you need some help on the board, some VC pedigree and connections to improve your team, domain expertise and maybe some money to buy out existing investors and their board seats. In that case, you'd be nuts not to go with, for example, General Catalyst or Sequoia.
The Surprisingly Common Use of "Structure"
In our A through D rounds, the concept of "structure" did not come up. In fact, when one of the potential Series E investors asked me, "Are you open to 'structure'?" it caught me off guard, because I didn't know what it was and didn't want to seem like a complete rookie. So I said, "Let me check with my board and get back with you." That turned out to be a good answer, by the way.
Structure is a fancy word for preferential terms set up to increase the return of the new investor, or limit the downside of the new investor. As I mentioned earlier, private investors typically need to get a 3X return on a late stage deal, and they're nervous that they will invest money into a company and six months later it will sell for 75% more than they invested. For someone who can reinvest that capital, that's a great outcome; for a VC, it's not. In order to protect themselves from that risk, they will ask for participating preferred stock that, for instance, will put a floor on their return of 2X. Given the VC's incentives, it makes perfect sense, but that is a different type of equity that sits on top of everyone else's equity that needs to be looked at extremely carefully. It comes in a lot of flavors and can work well to bridge a valuation gap, but can be confusing, so I recommend folks dig in and build the model on how it ripples through.
Another type of structure that VCs put in is a block on an IPO or trade sale of less than 2X (or something like that). This block makes perfect sense for the VC given their contract structures with their LPs, and it might make sense for you -- but you need to go into that with eyes wide open.
The surprising importance of your Series A terms in later rounds.
It turns out that the terms from your Series A are most often cut and pasted into your later round deals. When you compromise on terms in the early stages, you will have to pay the price in the later stages. You generally don't start from scratch and rehash the terms.
Surprisingly rational pricing
The initial pricing interest in our early stage rounds varied widely; but in our mezzanine round, the numbers came in much closer to each other. There are hard public numbers to look at with publicly traded companies and recent acquisitions by public companies. The pricing discussions just seemed much more "real" than the earlier stage deals.
My advice here would be to get your arms around the public companies for your industry, and where those companies were when they were your size. We built a chart that showed every public SaaS company and what their revenues and growth trajectories were from their early days to where they are today. It was a useful tool in our discussions, particularly when we were getting compared to public companies that were growing at 25% and we were growing at 85%.
Surprising value of currency valuation in M&A
Private companies buying private companies with stock is a tricky business. After our Series D, we acquired another privately traded company called Performable with a combination of cash and stock. The trickiest part of deals like this is figuring out what their stock is worth, and what your stock is worth. The nice part about just having finished a relatively late stage, clean round is that at least our side had a real number to negotiate from. If neither side has a recent number, those negotiations are really tough to sort out.
Those are some of the surprising things we learned in our recent mezzanine round. Am I missing any insights that you have on this topic? Feel free to leave a comment and let me know.
Brian Halligan is co-founder and CEO of HubSpot, a Cambridge, Mass.-based provider of inbound marketing software.
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