Recently I spoke to two founders that are in the process of raising an investment. They were in doubt if they should prefer a CLA or equity round. Since I get this question more often, let me share some considerations.
Case studies:
- company 1 is raising close to €1M, has little (recurring) revenue yet so hard to determine valuation based on multiples
- company 2 is raising about €3M, expects to increase valuation fast
CLA (equity later) vs. priced round (equity now) is a strategic trade-off. I think it’s a matter of 1) what you prefer and 2) what you can get away with. Let me explain:
What you prefer
CLAs (or SAFEs) are cheaper, faster and easier (in terms of paperwork) to arrange, so it is worth considering that over a priced equity round, especially if you plan to raise a small round (anything below €500k I recommend CLA). Raising (convertible) debt seems interesting if you expect the valuation will go up fast and you need a bridge to get to that inflection point.
On the other hand, any existing CLAs/SAFEs probably won’t convert in that case, which means that previous investors won’t also dilute in this round (mostly at founders’ expense) and they will only convert at the new (higher) valuation. If you raised at some valuation cap, it is worth calculating what this will mean in terms of dilution with some assumptions. In addition, you also have to take into account the maturity date of the existing CLAs; perhaps you need to start repaying or are requested to convert debt to equity anyway which can both be annoying. And of course you have to be able to repay the loan and pay the interest so it is also important not to have a too high burden on your cash flow that you need for growth, now or later on. In short, it really is a trade-off.
What you can get away with
Some investors want to have enough control over the company, so they prefer to join as a shareholder, with shareholder rights. If you plan to raise €1M+ from one investor, chances are that they will require preferred shares, maybe a board seat, certain consent matters etc. In other words, even if you decide you prefer to raise a CLA/SAFE it is still possible that you won’t find an investor that is willing to structure the deal in that way.
There are more considerations, and you can read them all in our Startup Funding Book, that I wrote together with venture capital lawyer Sjoerd Mol! Order it via bol.com, Amazon or your local bookstore.
