e27 reported towards the end of 2016 that whilst there is plenty of seed and series A money for start-ups in Southeast Asia the same doesn’t apply to series B financing. As the leading start-ups look to scale quickly, that may change, however, as new follow-on investors enter the market.
1. Start thinking about your series B round at series A
Yes really. Get your series A wrong, and the results could be magnified on the B round. Most of the time, series B investors will want all of the preferential rights provided to the series A investors as a starting point (along with additional rights they may request). So if you gave unusually favourable terms to investors at series A, these will almost certainly follow you through to the subsequent round. This can include items such as a participating liquidation preference (under which investors have their original investment amount returned to them on the occurrence of a liquidity event before any distributions are made to ordinary shareholders, and the investors then get to participate alongside the ordinary shareholders in the distribution of the remaining proceeds).
The economics of a participating preference may have worked for the company raising a smaller series A amount in the order of US$ 1 to 2 million. However, as the numbers increase significantly at series B, the effect of series B investors also receiving a participating preference could result in small returns for founders on an exit at anything other than a very high valuation.
2. Series B is not where all investors want to be
It has certainly been said before that a series B round is the toughest to raise. At seed stage, you may have little or no traction, raising on the basis of a great team and half decent slide deck. At series A, investors are looking at the development stage of the business and still taking a chance. Late stage institutional funds may be coming in at high valuations after the series B round, but the proposition at that stage carries less risk.
That leaves the key series B round fundamentally important for international expansion or product development, but hard to find and close quickly. The result, in our experience, is that series B deals can take longer to close with more extensive due diligence carried out. Therefore, seek a strong lead investor to help drive negotiations and lead the due diligence process.
3. Remember your series A investors
By the time you raise a series B round, you will already have VC investors on board. They will have a view on their participation in the new round (and will most likely have legal rights to do so) and on the terms of the investment. Even if existing investors are supportive of the new financing round, they may not want to concede some of their control and economic rights over to the series B investors. The reality is that they will need to. So founders must work to bring them on side, and balance their views against those of the incoming series B investors.
Aside from securing general board and shareholder approvals to authorise the issue of new shares, your existing shareholders’ agreement is likely to contain additional compliance requirements. Specifically, you may need the consent of a majority of your series A investors to get the deal done as a separate approval. Therefore, involve your series A investors early in the discussions so that they do not represent a roadblock to the deal process further down the line.
4. Key terms
Generally speaking, series B terms shouldn’t look too different to the series A terms you negotiated previously. One key difference can be the bargaining power. Your series A investment round may have been negotiated by a lead investor who retained much of the control in terms of veto rights on corporate actions. On subsequent rounds, there may be several major investors who could end up holding large and similar sized holdings in your company.
The result is that investor veto rights are often flattened out so that consent is given by a specified majority of certain preference shareholders. This is good for the company, as no one investor can then block key decisions as the company approaches the key stage of its growth. However, ensure that you are not required to seek consent from too many people which could slow down business decisions.
Once funded, it may be a strategy to acquire other competing businesses using shares in your company as part consideration. If so, ensure the company is not restricted from doing so. This will avoid obtaining waivers from all your shareholders to enable acquisitions to proceed.
5. Founder issues
With your business now established, there are good grounds for founders to ask that their personal liability (if any) under the investment documentation fall away. Often, representations, warranties and covenants at series B are given by the company only. This means that founders can focus on growing the business without concerns about ongoing personal risk and liability.
Similarly, on each new investment round there is a trend amongst investors to seek to reset the vesting of a percentage of each founder’s shares in order to incentivise those founders to remain involved in the company. By series B stage, founders might justifiably argue that only a small percentage of their shares should remain vested as they have been involved in the business for some time and have already provided significant value for their shares.
Series B transaction documents in Southeast Asia are fairly standard – particularly if your company is domiciled in Singapore. These usually include:
- A subscription agreement, which sets out the mechanics and terms of the investment, the conditions to be satisfied before closing, and any representations, warranties and indemnities to be given to the investors by the company;
- A shareholders’ agreement, which contains rights and obligations relating to the governance of your company and investor protections going forward;
- An updated constitution which, amongst other matters, sets out the terms attaching to the series B preference shares and replicates elements of the shareholders’ agreement;
- a disclosure letter, in which you list out disclosures against the representations and warranties set out in the subscription agreement.
Our experience is that you can save time and cost by persuading the lead series B investor to use your series A documents as templates for the new round. Doing so may avoid opening up old discussions on items such as the scope of the representations and warranties or the list of investor veto items for example. The documents will also be familiar to existing shareholders, ensuring less time spent on review.
Of course, using existing documents as the base documents for your new series B investment round does rather emphasise the point made under paragraph 1 above. Concede too much ground on earlier rounds and this may live with you as you approach your series B financing.
Lee Bagshaw and Chris Wilson are corporate lawyers at technology and VC law firm, Simmonds Stewart. They advise investors, start-up and high growth companies on venture capital financing and tech M&A deals across Asia Pacific.
The views expressed here are of the author’s, and e27 may not necessarily subscribe to them. e27 invites members from Asia’s tech industry and startup community to share their honest opinions and expert knowledge with our readers. If you are interested in sharing your point of view, submit your post here.
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