Mini blog on building Startups — How to raise 10 MUSD seed funding
I have a confession to make. I love convertible bonds. I know it sounds strange, but here is a story explaining why perhaps you should love them too.
Typically startups gather the first round of funding from friends and families to finance the early steps of the company. Then, after a year of struggle, if you are lucky and succeed in building something valuable, you can raise a seed round of a few hundred thousand USD from early stage investors. As a startup you are in a hurry to scale to the market, but your seed funding allows just miniature manouvers. The chances are that your startup is destined to fail already at this early stage due to too small amount of funding.
This kind of slow fundraising process does not make sense either for the startup founders, investors or to the economy in general. It is just too slow and wastes resources. If a large corporation would finance an R&D project, they would evaluate the amount needed to achieve the results, and then would allocate the needed budget for the project. Why can’t a start-up funding work in the same way?
How Jolla managed to raise a large 10 MUSD seed round
Jolla, a mobile OS startup which I co-founded, managed to raise a large 10 MUSD seed round in 2012, and avoided traditional slow fund raising process. Here is how we did it:
Jolla was a tough nut to finance. We basically needed a large sum of money immediately as building an entire OS with just a few people is not possible: you need 100 developers to get going. We needed enough financing to pay both for the salaries as well as hire subcontractors. At the same time, we did not have much to show to the investors. We had Nokia N950 developer phone with Qwerty keyboard and MeeGo OS to show, and our team’s background and know-how of MeeGo. This was my investor pitching material to raise the 10 MUSD. Obviously, I had to come up with an innovative, attractive and balanced offer, which would make sense to both investors and for the company.
What I came up with was a convertible bond. Convertible bond is an investment agreement where an investor gives money to the company as a loan, and later on the investor has a right to convert the loan into equity with the predefined terms. In Jolla’s case the terms we offered to investors were:
Invest 1/5 of the total investment now, and 4/5 after eight months after we have developed the first version of the mobile OS , the minimal viable product (MVP).
After the full payment had been made, the investment would be converted into equity at a pre-agreed valuation. For investors, this offer gave the possibility to invest into a big opportunity project with ability to manage risk level by following up how the project is performing and seeing that the team is able to execute.
In Jolla’s case the convertible bond worked perfectly. We got some money immediately to kick-start the project and hire the developers, and the whole organization knew that we needed to deliver the MVP to get the further funding and oh boy did we deliver! When we delivered, the investors paid the remaining 4/5 of the investment and we were able to scale up our operations. With the traditional small seed round approach, we would have gotten nowhere. However, one major negative aspect remained: the investors were stuck with their bonds and shares for several years, without a possibility to sell their bonds or shares when they would have wanted.
How blockchain and tokenization can make convertible bonds even more attractive to investors
Jolla’s seed round took place in 2012. Five years later, with the help of blockchain, it’s possible to make convertible bonds even more useful for startup financing. Let me explain.
Blockchain technology offers a possibility to split convertible bonds into cryptographic tokens, which can be freely traded, while blockchain keeps track of the ownership of the bond tokens. This might sound complicated to someone not familiar with blockchain, but it is actually really simple once blockchain is there to support the transactions and tracking the ownership of the bond tokens. Basically it is the same as how Bitcoin works, but we just replace Bitcoin with bond token.
Ethereum, another blockchain based technology, provides our token bonds even more juice. Ethereum was launched in 2015 and it uses similar blockchain technology as Bitcoin. While blockchain is a distributed ledger to record transactions with tokens and to keep record on who is the owner of the tokens, Ethereum adds smart contracts to these transactions, allowing us to define contractual rules on how transactions will be executed. The beauty of this is that we can automate transactions and be sure that both parties of the agreement will follow the contract as the software code executes the agreement exactly as agreed.
Having Blockchain and Ethereum technologies available, this is how Jolla’s 2012 convertible bond could be made in 2017:
- Jolla would create a smart contract on Ethereum, which issue 10 million bond tokens with face value of 1 USD each (lets call them Jbonds). The contract states that:
- Investors will get 1/5 of the Jbond tokens when they pay 1/5 of the investment to Jolla (2 mUSD)
- The remaining 4/5 of the payment will be hold in the smart contract waiting for Jolla to meet its milestone
2. When Jolla has met the milestone of delivering minimum viable product, the smart contract releases the 4/5 of the investment to Jolla and investors receive the remaining 4/5 of the Jbonds
3. Smart contract then converts Jbonds into Jolla shares which will be transferred to investors’ crypto wallet
Both Jbond and Jolla shares could be listed on a crypto currency exchange, making the tokens freely tradable. This has another major benefit to investors. Instead of being stuck with bonds or shares and having to wait for an exit to happen, investors can sell their bond and share tokens anytime they want.
Here is a summary of key benefits of tokenised convertible bond:
- Both investors and startup can avoid painful discussion of what is the valuation of the startup
- Startup can have flexibility on setting the convertible bond equity conversion rules: either fixed valuation or just a discount rate from next financing round valuation can be used
- Possibility to invite larger amount of investment in the beginning compared to traditional seed funding, which improves considerably the chances for success
- Reduces investors risk considerably, as they can invest in milestones
- Tokenised convertible bonds are easily tradable which makes the investment liquid
The new way of token based financing is emerging fast. Blockchain startups have already raised more than one billion USD worth financing with their token sales during the last 12 months. Token based funding is available also for other than blockchain startups (see my earlier blog “Startup funding can be disrupted with tokens”). While creating an own startup crypto currency is probably not suitable for many non-blockchain startups, the tokenisation of shares and bonds very much are. Let us jointly build such a future that the shares and bonds of all startups shall be tokenised and freely tradable in the global startup exchanges.
In case you are a startup founder and you find this interesting but a bit complicated, don’t worry. We have established Zipper to build the tools so that any startup can have an access to this kind of modern startup financing. Check us out at www.zipperglobal.com and join the discussion in Twitter and our Slack community channel.
Zipper community slack: https://slackin-qhgawovsyq.now.sh/
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