For those who are structuring the shareholder base or social capital of a recently created company, There are key aspects to take care of and take into consideration when building the social capital of an emerging company.
To talk about it, we invite Ludovic Prades, COO of Homie, and José Ramón del Río Rivero, a lawyer specialized in corporate and commercial law, both entrepreneurs with experience in these matters and who have worked with fast-growing companies that participate in the ecosystem of Latin American entrepreneurship.
1. How to close a deal
To close a deal, the points that have to be clearly addressed are: Why, How much, From whom, When and Howthis allows to design the Cap Table and identify key actions and milestones for the execution of the business project and the achievement of the following rounds of capital.
Ludovic Prades considers that many investors delegate 80-90% of their decision to the judgment and actions of a third party. Thus, it is not uncommon for some investors to trust an entrepreneurial initiative once there is a known or institutional investor committed to the investment round. By positioning the fund, you can pave the way for raising capital in subsequent investment rounds.
Once these first interactions have been had, it is time to go for the lead investors. It is these investors who help pave the way for subsequent investment rounds.
2. Who is a Lead Investor
For Ludovic, the role of lead investor it is twofold: it has a practical role and a marketing role. The practical one occurs when the investor who enters first is in charge of negotiating terms, the investment vehicle and other procedures. Marketing corresponds to the one that, the more important and recognized its name is, the better for the capital raising process. The initial investor can even be expected to invite other co-investors to learn about the entrepreneurial project in which he has invested.
As for the lead investor, there are no clear rules. In general, it is the one who makes the biggest commitment in the investment round, or it can also be the one who enters first. It is not uncommon for an investor with less investment, but with a better track record and recognition, to assume this role.
From the perspective of José Ramón, the role of lead investor It goes according to the DNA of the entrepreneurship, understanding where the project should move: “It can be the one that put the most money, or it is the one that brings the most relationships and contacts to the table. The famous smartmoney”.
Capital raising processes are always different, there are never two identical ones, they always bring their particularities and are great moments of learning, emotion and stress.
3. SAFEs, Convertible Note and Clawbacks to raise capital
The Convertible Note is the instrument that was used before, it has financial burdens for the company, so it is not of benefit to the entrepreneur. For its part, the performance of SAFE is given through the Cap Table or the discount that is agreed upon at the time of your conversation.
In addition, there is another negotiation tool called Clawbacks, where the valuation is fixed, which can be in the same SAFE based on the fulfillment or non-compliance of certain milestones or results. In this way, the Cap of the company is linked to the Clawbacks. This makes it possible to clarify the destination and use of the investment received.
4. Attract talent via Stock Options
One recommendation that José Ramón del Río considers fundamental is that the money invested in Series A be allocated to professionalize the Top Level Management team. To encourage them, a hybrid scheme is recommended where you have an attractive stock option and pay compensation.
As a good practice, there are the Vesting plans, where you give each employee shares and unlock them as their contract progresses, which is generally four years. Obviously, the earlier you enter the project, the more risks there are and consequently the proportion of shares tends to be lower.
5. What to do and what not to do when you are negotiating a Cap Table
In general terms, the closing process is painful for both parties, it will involve giving in. The important thing is the legal and fiscal accompaniment. From a technical perspective, when making an investment it must be understood that you will give up part of the control you exercise over your company. For this reason, good technical support helps to plan scenarios and to predefine courses of action on relevant equity, business vision or management issues that will be settled in the clauses considered in a contract.
For Ludovic, “the entrepreneur who accepts at an early stage that control is taken away from him in many aspects, does not understand how to play or has no choice. Which is why he is an entrepreneur you don’t want to invest in.” For this reason, it is very important to have a good lawyer, who protects the economic rights of the entrepreneur, making sure that there are no decisions that could harm him. In addition, it is advisable to have a board of directors to accompany decision-making. In investment rounds, advice is a fundamental factor in all conversations.
Understanding that structuring social capital is a great learning process, Jose Ramón and Ludovic summarize the key points:
- Planning and advice on tax and legal issues.
- Plan the sequence of funds, the investors with whom you will speak, the speech that will be given, how certain challenges will be addressed.
- Ask for advice from people you trust who have been in the situation you are going through.
- Do your due diligence.
- Go first with those that you know will not listen to you, because they will help you prepare for those that will invest, you will improve your learning curve.
Both agree on the importance of being accompanied by professionals in areas where there is no specialty and to be clear about what you want to offer, how you want to offer it and when you are going to offer it.
Luis Antonio Paredes Izaguirre Director of the Center for Research in Entrepreneurial Initiative (CiiE) of the IPADE Business School, he is also a professor in the area of Business Policy and a consultant in various companies on issues related to strategy, change management and innovation.