- First Round, a venture capital firm focused on early-stage companies, is assuring startups it will reinvest in their second round of fundraising when it led the first.
- The so-called “Second Round Guarantee” aims to take some of the pressure off founders trying to raise money in an uncertain climate.
- For some startups, First Round’s guarantee may be an uncertain boon. Not all startups want to give investors “pro rata” rights to reinvest and maintain their original percentage stake in the company.
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A top early-stage venture capital firm is guaranteeing some of its portfolio companies that it will reinvest in their next fundraising rounds — a pledge that could provide much-needed relief to young startups facing their first real economic crisis.
When First Round leads a startup’s first round of capital, it will exercise its option to participate in the company’s next fundraising, the firm announced last week. The pledge, termed a “Second Round Guarantee,” is meant to reassure some of the firm’s founders as they look toward attracting additional backing down the road.
First Round says its own stance could help portfolio companies land new backers. A lead investor’s participation in the second round can signal to other venture capitalists that it has continued confidence in the business or its founders.
Brett Berson, a partner at First Round, said it’s not uncommon for a startup’s potential new investors to reach out to his firm’s partners to ask if they’re participating in a subsequent round.
“I think that happens quite frequently because our goal is to be a trusted, incredibly strong brand in our category, and so, for obvious reasons, a lot of people come and say, ‘Well, what is First Round doing?'” Berson said on a call.
“It just makes it very simple,” Berson said of the firm’s follow-on funding guarantee. “We’re not, quote, cherry-picking or playing favorites,” he said.
When asked about our investment process, we always point folks to the detailed FAQs on our website. As founders face a future that’s more cloudy than clear, we’ve recently added a new answer.
➡️ More on what we’re calling the Second Round Guarantee here: https://t.co/x2o5MstsfI
— First Round (@firstround) April 30, 2020
First Round’s pledge commits up to $3 million in a company’s second round, specifically for startups that chose the firm to lead their first round. But the VC firm said it may not take up its full pro rata share of the new financing in order to maintain the same percentage of its equity in the portfolio company. First Round stipulates that it may invest less than the pro rata amount if the second round totals more than $20 million, according to the firm’s website.
The second-round guarantee isn’t a big change from the usual practice at First Round, which focuses on seed-stage companies as its name suggests. The firm said it has taken up its pro rata option 96% of the time for startups whose first fundraisings were led by First Round, over the last five years.
Still, the uncertainty created by the pandemic inspired the firm to make its routine practice a formal policy, Berson said.
“We think there’s a lot of value in simplicity and transparency,” he said.
The pool of capital is drying up
In a tweet, the firm announced it had added a new answer to a question on the FAQ page on its website:
“How will First Round support me in future financings?”
It’s not something that most founders often think to ask in conversations with a new investor, said Berson, who joined the firm in 2008. These days, though, First Round is hearing the question more often, as the coronavirus pandemic narrows the flow of venture capital to early-stage startups.
There are fewer deals closing, and industry insiders say founders should even be worried about venture capital firms reneging on term sheets they have supplied for funding deals in the middle of the economic crunch.
Business Insider asked a panel of venture capitalists if founders should be concerned about pending investment deals falling apart. Of the 18 people who responded, 17 people said founders should have some level of concern.
The situation may be even more dire for startups in their infancy, Berson said.
Their early rounds of funding have a higher concentration of angel investors, who bring their operating experience and their networks to the deals. But those individuals are not necessarily flush with cash, especially now with a looming recession that may threaten to decimate their public market holdings.
Angel investors don’t typically receive or exercise their pro rata rights in normal times, Berson said, and they’re even less likely to do so in the current environment.
To be sure, not all startups want to give pro rata rights to investors. Those options force the company’s founders to make room for existing investors in the next round, when they might have been able to fill the round with other venture capitalists offering better terms.
This is clever marketing, but not truly impactful. It’s more often that a founder DOESNT want you to take your pro-rata, so there’s more room for new investor and less dilution all around.
Most term sheets I’ve negotiated have included a clause FROM the VC insisting on prorata.
— Sahil Mansuri (@SVMansuri) May 1, 2020
Berson said it’s unusual for a founder to challenge lead investors who want to secure pro rata rights for their firms by including those rights in the first round terms.
The founders of some of First Round’s portfolio companies shared reactions to the investing guarantee on Twitter:
— Dave Girouard (@davegirouard) April 30, 2020
When my company was on the ropes, you tripled down. And it worked out in the end. Thanks Josh, founders *never* forget. It’s an example you set that I aspire to follow.
— Angus Davis (@angusdav) May 1, 2020