Terms, Baby — What to Expect When You Are Raising a Series A in Europe
Arguably one of the most useful skills an investor can bring to the table of growing a company is that of a seasoned fundraising advisor.
A typical call I would receive from founders looking for help would go as such:
“Hey, XYZ sent the term sheet. I forwarded it to you. Can you please give me feedback? Seems ok but I don’t know what the standard is.”
As a founder you rarely have time to benchmark legals and terms. You are busy building, selling and hiring. As an investor, keeping tabs on market conditions is a substantial part of our work. As such I set out — together with our Analyst Franz Sunyovsky — to analyse the most recent transactions in our portfolio to get a sense of what the ‘market standard’ for a Series A in Europe is at the moment.
Speedinvest is a seed fund. We are typically the first fund on the captable and at seed stage term sheets are by now reasonably standardised. From experience, this is not necessarily the case at Series A. Term sheets in these rounds still very much depend on the fund, the geography and the industry that the company operates in. Dealroom recently published a report on the likelihood of raising a series A after your seed round. What this report doesn’t cover and what we want to expand on, are the details of the terms of those rounds. The results are below.
The Sample — a Small Selection of High Profile European Financing Rounds
In total, we looked at 15 Series A funding rounds of European companies from 2016 to 2018. While this doesn’t include all the Series As raised by our portfolio, we picked the ones where the most known funds that invest in Europe wrote a check. This includes investments by Atomico, Whitestar Capital, Cherry Ventures, Redalpine, Earlybird, Index Ventures, Mangrove Capital, Northzone and Target Global. We are aware that this might not be an exhaustive set of terms and provisions that you as a founder might see, but it should provide you with a rough overview of what to expect.
The Basics — Equity Trumps Convertibles
One of the most frequent questions I get from founders is whether to do a convertible or a priced (= equity) round. Most founders would choose the convertible, most investors seem to prefer the priced round. In our sample 12 out of 15 rounds were equity rounds. And surprisingly, a third of them were using some form of milestone agreement and tranches instead of releasing all the money right away. A quarter of them saw secondaries for other shareholders or previous founders that might have left, happen.
The Money — All That Glitters is Not Gold
Two things founders usually care most about when raising are the amount they can raise and their company’s valuation. Absent the availability of public revenue or user numbers, fundraises and valuations are often the only yardstick by which founders can compare themselves to their peers. A large fundraise can serve as a source of external validation in the daily grind, an indication that you are “on to something”. Our sample shows though, that the 4–6 million round is much more common than the 10 million Series A that you read about on Techcrunch.
The round sizes ranged from 3.5 million to 11 million Euros, with the median at 6 million (in it’s report Dealroom defined Series A from 4 million $ and up which is roughly in line with what we see here). One reason might be that in press releases companies often conflate multiple rounds or add up stacked convertibles that occured in-between rounds to boost round size.
The second component of the round is the valuation and the resulting dilution. The number that investors most care about is ownership. The valuation therefore follows logically from the investment sum and the target ownership. Most funds have a number of deals (and a ratio of initial and follow-on investment) in mind. For their fund economics to make sense, deals need to be in a certain range and to make the fund model work, they need a certain minimum ownership. That percentage lies between 16 % and 40 % in the sample, with median and average at 23 %. Simply put: be prepared to give investors roughly 20 % of your company in Series A.
Lastly, the corollary of valuation and investment sum is the post-money valuation. In our sample we saw post-money valuations between 12 million and 65 million, with the median at 22 million and the average at 26 million Euros. To sum it up then: a 6 million series A at 20 million pre-money valuation (26 million post-money) is a good deal, where 23 % of equity is transferred to investors.
The Ownership — Dividing up the Pie
Having looked at the round size, it makes sense to look at the composition. There are two types of investors in any financing round: new investors (often multiple) will come in and some old ones will want to participate to keep their stake (the so-called ‘pro-rata’). In our sample new investors on average make up 77.5 % of the money raised in series A, while existing investors take the remaining 22.5 % (which is in line with the typical dilution in the seed round). There are some extreme cases. Occasionally the new investors will aim to take the whole round not leaving any room for pro-ratas. On the flipside, sometimes they’ll only take about 50 % of the round because existing investors want to ‘double down’.
To get a full picture of the commercials, we need to include the ESOP pool or any other form of stock options reserved for employees or advisors. They are typically ‘paid for’ by existing shareholders, including the founders, through dilution. The new investors will almost always (every series A investor in the sample asked for this) request a ‘top up’ of the ESOP pool to a certain level, most likely before the round, to incentivize future hires. The consensus for the size of the option pool after the investment seems to be around 9%, but frequently up to 15 % of the shares and rarely below 5 %.
The Terms — En Route to a More Founder-Friendly Ecosystem
What many founders don’t care about until the very moment it becomes relevant are all the other terms in the agreement. Let’s start with the most standard clauses. Founder vesting is one of them. In all cases the clock for founder vesting was restarted and set to 36 to 48 months. Only one used a cliff and the vesting schedule was usually set to monthly or quarterly vesting. Secondly, all the investors wanted a board seat. Half of the cases also granted one observer seat to the new lead investor.
On the more nitty gritty stuff, it’s important to understand that investors invest to divest. It means they want to sell their stake at some point. In what way or form varies but there are certain provisions in every term sheet for that. A quick rundown:
Who gets money first? Increased liquidation preferences are luckily a thing of the past. All but one term sheet had a 1x non-participating ‘LiqPref’. The one outlier had a 2x on the money invested in series A.
What if someone has a buyer? Co-sale or tag along rights are there to allow other shareholders to sell under the same conditions. The standard for tag along seems to be pari passu and pro-rata, so under the same terms and to the same extent as the seller (so the same percentage that they are selling). In one case the majority of shareholders had to agree to that co-sale.
What if someone wants to sell? Drag along rights are a way to make exits possible. They ensure that when a major shareholder wants to sell, it can force others to sell as well. That’s important because investors want to have that option, but needs careful examination in terms of who needs to approve it. The transactions had all kinds of variations. Here is a list with the number of cases in parenthesis:
- Majority of Investors/Preferred Stock (2)
- Majority of Common Stock with Investors Consent (2)
- Holders of at least 60/65/70 % of Stock (all classes) (3)
- Majority of Common Stock and Majority of Board (2)
- Other combination of Share Class, Investors consent, Board Approval and/or individual threshold (6)
There is no one size fits all. The clauses reflect the composition of the captable, the round and previous agreements.
Pre-emptive WHAT? If you ever wondered what pre-emptive rights were, a series A term sheet is usually the moment to figure that out. Essentially they are a way to structure who can buy shares from whom, if anyone wants to sell. This provision is usually found in every term sheet, but the mileage varies:
- All Shares (6)
- Shareholders with more than x % (usually 1–5 %) (1)
- Preferred Shares (2)
- Preferred Shareholders with more than y % (usually 5–10 %) (2)
- Preferred and Founders (1)
- Lead Investor only (1)
In more than 75% of the deals we saw that lead investors required an Anti-dilution provision. While in Seed that is a no-go, it’s common in later rounds, and the standard is “broad based weighted average”.
What about the costs? Lastly, there is no such thing as a free lunch. Every financing round will incur some cost. In most term sheets there’ll be a cost cap defining to which extent the company bears the cost of any financing round. This typically only entails legal fees, when historically there were also agreements adding due diligence costs of investors to this. That’s no longer common practice. The cap ranged from 15k to 80k Euros, with one agreement that had costs uncapped.
I hope this analysis has cleared up some of the most common questions about series A terms in Europe, thanks to Fred Hagenauer for making it a fun read and Franz for digging up the data. If you have any questions feel free to let me know, if you have feedback I am happy to hear it!
PS: We live in a post-series world, so don’t get worked up about raising a picture perfect series A. It’s just about getting what you need, to get to where you want. In the end, it’s all about building a company. Raising money is just a means to an end. Don’t see it as a competition in itself.