So you closed your first funding round and you achieved to sign in the VCs at the top of your list. Congratulations! I wish I could tell you that after this everything is much easier but no, it is not (and that is the interesting thing!). Now you must not only fulfil your own expectations about your company but also your investors’ expectations (tip: make sure both are aligned). Sometimes things go great, sometimes not so great. When they don’t, you might find yourself needing capital but with no time or plan to raise another financing round soon. Then opting for an inside round might be the answer for you.
What is an Internal Round/Inside Round?
Also known as Bridge Financing, by definition, an internal round is when you raise funds from your existing investors. Usually, this happens with an equal or similar valuation as the previous round unless the inside round had been a consequence of the company’s positive performance and not the lack of liquidity. For matters of this post, let’s assume we are talking about the latter case.
So you are there, needing $500 k extra to achieve the milestones you agreed to before raising your next funding round. What do you do?
It is all about communication (and expectation management)…
As soon as you realize that you will be needing some extra cash, communicate this with your investors and talk about the possibility of having an inside round. You must start the talk early, and not one or two weeks before running out of cash. If you do it early, you will have two advantages: a) time to assess all your possibilities with your investors and, b) show the good leader you are; one that can take control of situations even in not so good times.
Talk with your biggest investors…
As investor it is not the same to hand $100 k than $2 million extra. Focus your efforts in your main investors. First, communicate and negotiate with them. If you achieve to get them on board, the logical reaction of your other small investors is to follow them.
Get to know the rules of the game…
VCs have internal processes, and some decisions such as inside rounds sometimes need the approval of all partners. Therefore, when you talk with your investors about an internal round, don’t forget to ask them what are the internal processes in their VCs to support an inside round. Ask about who you need to talk to (maybe you need to present your case to other partners), how much time your VCs need to make a decision and, very important, if you need to find an external investor.
Another great way to know the rules of the game is to talk with the entrepreneurs who already have had internal rounds with your investors. Ask them about their experience and the unwritten rules of inside rounds with your investors.
Decrease your burn rate (your investors will appreciate it)…
I know what you are thinking, and jeopardize my growth? Well, sometimes is better to reduce the speed to get the bases right so you can accomplish your milestones in the future. Besides, if you reduce your burn rate at least until you achieve your milestones, investors will feel more comfortable supporting your inside round as they will see their risk diminished.
Explore your other options…
An inside round is not your only option if you are running out of cash and have no time to raise another financing round. Pursuing an acquisition or a downsize round with external investors (financing at a lower valuation than the previous round) could be your plan B. Probably these solutions do not sound so great under these conditions; however, remember that being a good entrepreneur is also about being able to survive and get the best of every situation.
Sources: I got some good insights from Mark Suster´s snapstorms, the rest comes from my own experience in VC.
Also published on Medium.