7 consequences of a successful round (apart from cash!)
Let’s face it, when you’re raising finance, you’re after the cold hard cash, first and foremost.
But you will get a lot more than just the money. Some good things, some challenging.
Here are 7 important consequences of raising a round that you really should consider before embarking on your first investment round.
1. The paperwork lands before the money
Raising money is seriously time-consuming.
Even small rounds raised from friends and family usually come with a lot of admin, which grows considerably with every round.
Usually this needs completing before the money arrives, or sometimes shortly after.
In almost every territory you have to let the authorities know (e.g. filing new share issue docs with Companies House in the UK or adhering to SEC Reg D rules in the USA) and you really should issue contracts (such as share subscription agreements) to new shareholders.
In fact, if you haven’t got a lawyer involved, then you probably should, because most jurisdictions have laws on how you can and cannot raise money as a private company.
You need to understand these rules.
Penalties for non-compliance can be serious.
For example many territories, including the USA, have rules about how you can market your fundraising and who you can approach to be investors.
You might be able to do some of this in-house but specialist law firms, accountancy firms or corporate financiers will ensure that the correct rules are followed, forms are filed and documents are produced, signed and stored safely.
Your investors will definitely want to see this if your location offers tax relief schemes (such as SEIS/EIS in the UK). Investors will almost certainly rely on you making a successful application for one of these reliefs.
In fact, your investors are relying on this.
Employment agreements, share subscription agreements and employee option scheme agreements all protect the rights of everyone involved against unexpected outcomes, not to mention providing reassurance to both investors and founders.
Don’t ignore these (even if some say they aren’t necessary)!
Get this stage wrong and you, the founders, could find yourself legally locked out of your own company.
This happens to games companies more often than you think.
Finally, there’s the small matter of your existing shareholders - they’ll need to formally approve all these ramifications.
Key takeaway: Prepare for lots of admin and paperwork, before the cash arrives.
2. You and your shareholders get diluted
It’s a given that equity investors get a chunk of your company in return for their cash. You and your existing shareholders will get diluted with any equity funding, irrespective of how well you negotiate, how much you raise and at what valuation.
Dilution in itself is not bad. Having a smaller share of a much larger pie is typically better than having a larger share of a much smaller pie.
Valuing companies is incredibly difficult and there are a ton of ways of doing this but ultimately what it boils down to is finding a mutually acceptable valuation of your current company (called a pre-money valuation) that both the investor and investee are comfortable with.
Get that right - by which I mean not so overvalued that the investor is put off and not too undervalued that your company is worth less than it should be - and you’ll be able to strike a good deal, at least for a while.
Although valuations tend to be lower in the UK and Europe compared to North America, the amounts raised also tend to be lower (due to lower costs and fewer/smaller investor funds) so dilution is often similar at the equivalent stage. Compare your valuation with overseas companies’ valuations with caution!
Key takeaway: Balance incentivising the investor to invest and existing owners, like management, to grow the company.
3. Your board could be strengthened
Usually, investors of all kinds want to sit on the Board and have a say in what you do.
This is typically a very good thing because most investors have experience and connections that can contribute significantly to your company’s success.
Their support, knowledge and contacts could be critical to the studio’s survival, growth and exit, as well as helping you tackle the challenges you’ll face as you grow.
But things don’t always go to plan.
Keep an eye out for bait and switch at this point. Will the senior investor you like actually attend board meetings or will they deputise someone more junior?
Also, if you haven’t run a company board before, you could find this has a steep learning curve. You’ll be managing some big personalities of people paid to have strong opinions. More on that below.
Finally, beware of having an oversized or unbalanced board.
Oversized boards are impractical to manage. I’ve run boards with over 10 members and it can be hard to get everyone’s opinion without the board meetings lasting all day.
Boards that have more non-execs than executive directors are dangerous as the management can be outvoted. Avoid both of these scenarios.
Key takeaway: Find investors whose support, knowledge and contacts help your company grow.
4. Your voting rights may also get diluted
You will almost certainly hold less control over your company after each equity investment round, which can mean that the management team’s strategy for the company can be influenced (and even reversed) by investors with different agendas.
Depending on the size of the round, voting rights could be written into the contract differently to share rights. Some games investors (particularly games companies, so called ‘trade investors’) expect substantially more voting rights than their equity share of the company. It’s essentially a tactic from larger games companies who aren’t ready to acquire or take a majority share but will take a minority share which holds a promise of a future acquisition.
Mismatched voting rights should be a warning bell for you as you negotiate.
Ask why your potential investors want to invest a small amount but demand a greater degree of control of the company? Are they worried about competitors, market position or other board members?
In particular, look out for ratchet mechanisms in the contract that allow the investor to gain more votes (or shares) under specific circumstances.
Your existing shareholders will want their concerns addressed about this.
If you’re going to agree to handing over more voting rights, then try to quantify what you will get in return, such as guarantees around distribution, production funding, publishing or marketing support.
If you accept that the money and the kudos for adding their name to your board are alone worth ceding more control of the company, then at least do this with your eyes open.
Again, the location and personalities of investors will govern how aggressively they negotiate but on the plus side, these negotiations will tell you a lot about who you’re partnering with and also, what they expect in future.
If in doubt, ask!
Key takeaway: One share, one vote is simplest but only agree changes to voting rights with your eyes open.
5. Once you start fundraising you might never stop
Winning a nice round often gives the company some breathing space to grow but the runway often ends sometime, perhaps sooner than you expect, and you may need to start fundraising all over again.
Your new investors may well demand you chase repeated rounds.
They may well have targets, such as your valuation rising rapidly.
So before you know it, you could be on the road again raising another round.
For many games CEOs, raising money and managing investors takes all their time.
First of all, be reassured that fundraising a second round is almost always easier the second time around. You’ll have completed the process of pitching, negotiating and closing a round before. Fundraising will be a known quantity by then.
More importantly, your new investors will become a key asset for your next round not just because they know people (such as other funds they have fed into before) but because they may follow on and invest again to protect their overall share of the company from dilution from what would hopefully be a higher valuation.
A future round could of course be a down round, which has all kinds of implications, which we’ll tackle in a future post.
The senior team needs to take on board that the gap between rounds may be short and that whoever leads the process could be tied up for most of their time.
Key takeaway: Your 2nd round may start sooner than you think and take most of your CEO’s time.
6. The amount of reporting will go through the roof
Raise that money and you’ll quickly find out that the days when you and your team could make decisions without checking with anyone first will be gone.
All investors want to see good governance.
For most investors that means the senior team will have to be measuring and projecting company performance regularly, and reporting to shareholders at least quarterly if not monthly.
Delivering that usually means financial and project management tools that track, quantify and rate delivery and finances.
On the downside, becoming this accountable for most games studio founders means that there’s less of the fun stuff and more project, relationship and financial management.
On the upside, it usually strengthens the company, makes life more predictable for everyone. You might find that after setting these processes up, you wonder how you did it without them.
It’s worth investing time, budget and capacity to get this right and your management team may grow.
Key takeaway: Reporting your studio’s performance systematically will make managing the company and your investors easier.
7. Your team will grow, so diversify!
Investors may want to plug any perceived gaps in your senior team shortly after the round.
That could be on the exec side, such as splitting roles to create new directors, or the non-exec side, such as people with experience and contacts that will be strategically valuable to the company.
How your management and non-exec boards change will vary depending on who’s there already, but if you didn’t have a senior finance person in the team, your first major round will probably be the trigger to hire one.
A Finance Director or Chief Finance Officer could be critical in freeing up the rest of the management team to deliver the plan. Although some of it will still be your responsibility, a new Finance Director should ensure you don’t have to worry about producing all these reports alone.
A successful round is a golden opportunity to diversify your team.
Add more voices to the mix.
Diverse non-Exec boards have been proven to make more money. A more diverse board will deliver more viewpoints around the table, trigger more robust debates, which in turn will strengthen your company’s decision-making. Embracing these perspectives will make you a better operator and leader too.
Bringing in diverse, experienced and reliable management who can deliver for the company won’t put investors off. They should appreciate you protecting their investment.
In fact, across the entire studio, diverse development teams make better games in our experience.
A diverse dev team is a no-brainer isn’t it?
Getting people from different backgrounds making games for your diverse players should be a given in our most creative of industries.
We’re not recommending you box tick here but you may have to go the extra mile. Don’t just recruit the guy who did that thing with you back in the day. Spread the word more widely, encourage diverse candidates when recruiting and you’ll find some great candidates.
Key takeaway: A round is a golden opportunity to diversify your board and entire team.
Have any questions - join the discussion with us by commenting below
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