So Why Not Extend The Previous Round? Benefits, Mechanics And 3 Reasons Why Startups Should Not Do It
Most startups that are on a healthy trajectory will find at some point that VCs want to put in more money. Sometimes it’s existing investors but more often than not it’s newer parties to the table. Most of the time the entrepreneur can defer the conversation of taking in more money but if you haven’t achieved the milestones fully to call it the next round, you may be tempted to just extend your previous round. This post will discuss the benefits, mechanics and then three key factors to weigh in.
There are obvious benefits of taking money when you least need it:
- Runway — have even more legroom for the company, perhaps take longer bets with higher yield
- Terms — command better terms
- Diversification — optimize your investor base further so you don’t over-depend on any single VC
- Signaling — signal to the market strength which helps especially in BD, sales, and hiring
Once again, we are talking about the situation where you are on a good trajectory ie this is the case of inbound investor interest, not where you are seeking money out of pressing need which is often labeled as “bridge round.”
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The mechanics of extending your previous round are similar to doing a new round, and it depends especially whether you are doing a convertible note or priced equity.
A common scenario is you did a convertible and extend it with a different discount rate to reward existing investors for the higher risk they took. This happens often in the seed and entrepreneurs will often label it “seed extension” or a “pre-A.”
Another typical scenario is you did a priced round and now offer a convertible towards the next round. This happens often in As, Bs or Cs rather than later rounds and entrepreneurs will often label them as “series X extension or “series X1” where X is the previous round.
All this said, there are fundamental reasons to not to take the cash. Below are three factors to weigh in before you extend your previous round:
Reason #1 Not To Extend Your Round — Dilution
It goes without saying that doing a round will dilute you further. If you are not as concerned about dilution as you are about being in charge, it is obviously possible to structure different classes of share so you give up ownership without giving up control. But your investors may not agree to founder shares or more complex structures. Remember also that what you negotiated today has downstream effects, especially as you want to incentivize future hires — typically post series A startups allocate 10% of shares for future employees.
Reason #2 Not To Extend Your Round — Distraction And Signaling
A good fundraiser takes 3–6 months but if you are in a position of strength and agree to extend a round, chances are you can close much quicker. But mind you, many companies that are extending a round are doing it out of necessity rather than choice and you will face a perception issue. And on top of having a coherent narrative, it can be a distraction from continuing to build the company. Many startups that find themselves in this dilemma may agree to an insider round to get it over quickly, but the market will generally interpret that as you needing the cash. So the common sense advice for extending your round when your existing investors want to increase their ownership is to have them wait till the next round and bring a new investor on board. All of this obviously will end up taking some of your mindshare.
Reason #3 Not To Extend Your Round — Culture
Cultural impact is usually the least obvious reason in raising more money than you need, as its effects are subtle and long-term. Even if you continue running the business just as before, having more cash in the bank very likely will affect the decisions management takes and even general execution. Being a little extra frugal and hungry is mostly good for a startup, especially at the early stage. If you have a very specific plan for the extra money then, by all means, follow your strategy. But otherwise, treat the extra money exactly like that — it is extra money that is sitting in the bank and that you won’t touch unless absolutely needed.
These are purposely short articles focused on practical insights (I call it gl;dr — good length; did read). I would be stoked if they get people interested enough in a topic to explore in further depth. All opinions expressed here are my own. If this article had useful insights for you do give a like, any thoughts comment away.