The Round Within The Round (Investing, Not Concentric Circles)

Lately I'm observing with founders when they're raising a round of equity investment is the need to drive progress and traction. Many people, when they look at the word traction, think it means revenue or users growth (or public notoriety). In this case I am referring to none of these.

But there is a smaller version of traction in the world of fundraising. And that is, what other funds are you talking to? How much of the round is already committed and called for? We'll call it FOMO, sometimes falsely created by founders. In reality, if you have a good deal, it can create a sense of urgency that people would want to invest in it.?

What Is This Round Within The Round?

So this round within the round (reference in the title of this article) is something that I'm seeing is becoming more common. What I see is that it's easier to find the strategic or passionate individuals that would want to invest in your company. There are two scenarios here. One is that you establish a lead institutional investor, and then you reserve part of the round for these strategic individuals and angels to come alongside on the exact same terms. However, sometimes when you're talking to both parties - strategic individuals and family offices and institutional investors -the individuals and family offices are able to move more quickly.?

This is where a round within the round is created where a subset of the round is taken up by individuals and family offices. And they're willing to take action. Now, this is where I see that individuals, founders companies will set up an SPV to run this process. So if you're raising $1.5 million, maybe you have upwards of $500,000 soft circled as the terms that people specify. But in reality, sometimes that soft circle, those individuals are willing to send you the money right away. They want to get into your deal before other institutions come to the table and take over the whole round. So many times, I see founders beginning to take these checks through a special purpose vehicle, keeping their cap table clean, and at times, giving them a slight incentive to take action.?

An example of which would be that a founder might give a 10% discount on a convertible note to a priced round that's about to happen in the next month or two. I'm finding this more and more common, this slight discount to drive this sense of urgency.?

Why Would A Founder Utilize This Methodology?

Why would a founder do this is the question. Many times, it’s being able to say that $500,000 is already closed. The round helps other people feel confident of what's moving forward and that helps the institutional investors feel like this deal is moving forward. Also, the value of that cash is being able to operate as if you've already closed.?

The $500,00 allows founders to progress in their revenue and take action to grow their company, which is the key thing that institutional investors want to see. So this round within the round is something that's not happening all the time, but it's something that I'm seeing founders take advantage of because they're able to more easily identify individuals or family offices and run a consolidated process of getting them into the room.?

It's difficult at times to balance because institutions may seem like they're interested and individuals may seem like they're interested. The end goal is always the same. How do you encourage a decision? Sometimes incentivizing the decision from individuals and family offices first can function as a strategic advantage or sometimes incentivizing an institutional investor to set the terms and have all the individuals follow can be an advantage. The evaluation is for each founder to determine what's the best way for you to close a round. And it may be to consider this round within the round.

I would say I find this practice most common in round sizes between one million and three million dollars. This is because raising from individuals in family offices can be impactful. Closing $250,000, closing $500,000, closing a million dollars in those round sizes can move the needle and cause you to operate as if you've already closed the round.?

Types of Companies Where The Round Within The Round Is Prevalent

Also I tend to see it occur with two types of companies. One is a company that has a founder with deep relationships. Generally speaking, founders like this are a little bit older and they have relationships with people with capital that they've built up over years, relationships with trust and those people want to invest in them.?

The other is a company with significant traction. This is not a “quick sketch on a napkin” idea that they're trying to move forward. It's an opportunity where they already have proven revenue and are progressing faster than what they anticipated. And therefore institutions are having to play catch up to learn about a new opportunity and evaluate the attraction.?

An Example

The times I've seen this work really well are the times where you have individuals who are truly interested in the business and they are open and willing to make a decision. Therefore the founder is able to drive the sub-round forward.?

One example is a female founder I know who had built up an existing customer base that was pretty impressive for an early stage company, but institutional investors weren't quite sure that it was a large enough market or that the sales process was repeatable. But she was able to drive investment of almost $300,000 to her deal. And she made the announcement of the deal plus she had the individuals involved promote and support her company after they invested as well as bringing their value-add relationships to the table and it all caused her to get more attention. That in turn caused her to bring more strategic individuals and investors to the table and from there she landed even more customers.?

As greater customers came to the table over a two-month period, she had multiple institutional investors come her way after closing this round within the round. And it worked out really well.

Where This Can Backfire

Where I see the round within a round backfire is oftentimes that founders will create a false sense of FOMO and try to force a decision or allude to the fact that other players are getting involved before they're actually involved. I've had founders present this as, “I've reserved part of the round for strategic individuals.” They claim that this group of individuals are very serious about giving a term sheet.

But it’s an amazingly small world and then other prospective investors find out through the grapevine that those funds were indeed not interested nor progressing. Not good. Sometimes that had to do with the founder’s lack of understanding of the VC's progress path. And sometimes it had to do with trying to create a sense of urgency and that very much blew up in their face because any of those individuals in the process of evaluating no longer had the trust or the desire to participate in a round that hadn't really come together yet.?

So it's just being clear and upfront about what your goal is. “I'm closing this amount from individuals so that we can continue to progress and we believe we'll close within the next month or two.” “We're actually already in conversations with five VCs.” If those statements are true, that's a really reasonable conversation to have with other prospects.?

What To Do To Create a Successful Round Within A Round

What to do to create a successful round within a round… the first tip is to ask for a decision on a specific timeline. It's better to get to a quick “no” than it is to prolong the decision-making process for individuals. It doesn't mean you write them off if they say no, it just means that they're no for now.?

The second tip is to offer an incentive. An example of where that might work is a discount - so if you invest in the next 30 days, you would get a 10% discount to the round.?

The third tip is to be willing to take feedback when you're talking to individuals and industries. It's important to talk through the details of what you're still trying to figure out. If you're an early stage founder, you haven't figured it all out and there’s nothing wrong with that. You want to listen to the feedback. It's okay to understand that some of the feedback you get won't be accurate, but it's important to listen anyway. Be upfront about what you do have figured out and be upfront about what you're still working through.?

The fourth tip is to ask questions about what this group or individual would need to understand in order to make a decision - you want to know their investment decision process. You want to also evaluate if they’re a fit for you, and if their process is too long or there are too many people involved or they need more information than you have the time to put together, then you want to find that out up front so you can politely step away from them, for the time being anyway.?

This is why we educate founders on how VCs make decisions, because it's important to ask. Every firm has a different process. Sometimes it's within a six week period. Sometimes it's a four meeting situation. Sometimes it's a six month process.

For the investors reading this - the company you should have invested in - may have already left the dock. It might not be too late - or maybe that was the right boat to miss.

Image Credit: LONG SAIL — PALETTE KNIFE Oil Painting On Canvas By Leonid Afremov