Venture Capital

In Everyone-Wants-to-Get-Funded Season — Be Careful Before You Say No To That Internal Round

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Jason Lemkin

It’s hard to keep track of all the unicorns these days, but there was one the other day that I saw a bunch of mis-thinking on: Okta.

Okta is a leader in single-sign on security and recently joined the paper unicorn club, raising $75m at an apparent $1b-ish pre-money.

From its existing investors.  No new lead.  No new fancy-pants VC to cut the unicorn ribbon.  Just the same old VCs from last time.

Screen Shot 2015-09-10 at 9.21.56 AMA bunch of Tweeters and others jumped on this as a negative sign.  That the fact that the exact same guys — Andreessen Horowitz, Greylock Partners, and Sequoia Capital — invested at a large step-up from the last round, just last year, was somehow something less than real, something less than a victory.

Maybe.

But hold on.  Assuming the press is accurate, this wasn’t a downround, or a flat round.  It was a UNICORN ROUND!

What happened?  Here’s what happened:

  • The investors liked their investment.
  • It was one of the better ones in their current portfolio.  So —
  • They wanted to own more.
  • So they doubled down.

Plain and simple.

In case you missed it, Sequoia did this in WhatsApp, too.  That worked out.  Andreessen Horowitz did it in Zenefits.  Got a 10x step-up pretty quickly from there.  Etc., etc.

The point of the story isn’t Okta, who cares.  You Okta, I OneLogIn.  Whatever.

The point is we’re heading into Everyone Wants to Get Funded Season.  And these days, with a record number of new funds raised, if you are doing well — more of you will get offers from your existing investors to put more money in.

Let’s start with the Cons.  Because the Pros are more interesting, and more in number and significance than they look.

Cons:

  • No additional validation.  I mean, I’d think with Okta, those VCs would be enough validation.  But yeah, we’re all score-keepers.  Not having a new lead is less validation, at least, sort of, to the outside world.  If u care.
  • No additional pockets.  This can be an issue.  Even the biggest funds don’t have an unlimited pocketbook.  Each big investor you bring in, you add more pockets.  Now, the biggest firms have “tricks” to make their pockets even bigger (SIVs, Opportunity Funds, direct investments from LPs).  But even so, not adding another player is one less source of capital.
  • Maybe — worse valuation.  Maybe.  Sometimes, an internally-led round isn’t the best price you can get.  Especially if your investors don’t usually do rounds “later” than the current one.  Take me.  I’m a partner in a $180m fund.  I can write a $500k-$5m check fairly easily.  But that does put a ceiling on my valuations, implicitly.  But … sometimes, your insiders will give you the best valuation, as long as it’s fair and has context.  Because they can dollar-cost average.  Especially if they don’t see the investment as being super risky.
  • And — that’s about it.  I’m struggling, folks.

Pros:

  • No need to give up a board seat or any additional control.  The seats at the table don’t change.
  • Much more percentage ownership / dilution flexibility.  If I already own 10%, maybe I’d like to “buy up” to 15%.  But that also means u only have to sell 5%.  If you are dilution sensitive and the valuation isn’t Unicorn-y, you can potentially optimize a round size (and thus dilution) much better with the insiders.
  • No due diligence, no deal risk, more time efficient.  Because the work’s already done.
  • No bozo risk.  You already know the bozos on your board and in your syndicate.
  • It’s a huge vote of confidence, an inside-led upround.  That’s something.

So I think the Pros are bigger than they look, and some are subtle.

Screen Shot 2015-09-10 at 9.18.05 AMBeyond that — look, I know you are Super Hot.  If you have 11 term sheets, pick the best one, of course.  #founderpower

But … there are only so many VC firms.  And VCs get tired.  They do too many investments.  Maybe they’re done for the year.  Maybe something comes up in diligence.  Maybe your competitor does something crazy.

Take a look at the Mattermark chart at the right.  There are only so many folks to fall in love with your start-up.

If your insiders are so in love, and want to deploy more capital … don’t dismiss it too quickly.

And remember, if you do pass on an attractive, inside-led round … and then you have a rough month or two … the offer can quickly disappear.  Inside offers are a higher bar for VC partners to get done among the rest of their partnership.  Because there isn’t that outside validation.

Personally, I’m kinda full, and a smidge tired.  I may not do another investment this year.  I’ve done 10 VC investments in the past 14 months or so, which is a lot.  But I’m totally down with putting more into my winners, any day of the week.   Of course I am.  It’s the easiest possible way to invest and make money as a VC.

Published on September 11, 2015
  • You covered it all and they are all valid points in my opinion.

    However, I think you watered-down one key point – “more time efficient”.
    If money is a commodity, time is not, it is the most scarcest resource. Optimising on time and a little bit less on valuation, is a win for all.

  • If momentum is hot, fundamentals are strong, and the market continues to demonstrate acceptance of the product/service and grows accordingly, doubling down is often a no-brainer. I agree that I struggle to see the cons as real cons. The biggest problem as a firm would be if you can’t reasonably participate your pro rata share of the last round into the next, for example, if reserves were left a little light and most of the fund’s capital has already been deployed.

  • Plus you do the right thing by your friends and supporters. Makes social sense as well as financial sense.

  • Cody Boyte

    I watched a friend of mine bypass an inside round awhile back in search of a better outside round.

    He spent months pitching VCs, found one at a decent valuation, but then had the round break down. It scared off other investors and he eventually had to pull together a last minute round at a little better than half the valuation he was offered by the insiders at the outset.

    Sometimes it’s better for everyone to just take the inside round and get back to work. Especially if you’re making good progress. Taking your eye off the ball to go find funding can cause you to make mistakes.

    • Jason Lemkin

      +99

  • I think that Sequoia, Horowitz … are companies that really, and I mean REALLY, want to change the world. And for this, you need to invest with your heart, too. Who knows – maybe – as you said, they got bored in the process of JUST making money.

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