Female Foundry Week 75: Protecting valuations & cap table chaos. Dry powder misconception. Follow on funds are rarer than you think. Where you are still matters. Female Foundry x TechBBQ.
Welcome to The Week 75, 2023 Edition of the Female Foundry newsletter!
Female Foundry - where investors and female founders meet.
In the news
Berlin-based Meshcapade, co-founded by Naureen Mahmood, picks up a €5.5m Seed round led by Matrix Partners for its 3D modelling platform; Remote gamings startup Versed, co-founded by Cat Burton, fetches a €1.6m Pre-Seed round from Gradient Ventures, Google's AI- venture fund for its text to RPG platform; Munich-based Heynannyly, co-founded by Anna Schneider and Julia Kahle, raises a €1.6m Seed round from multiple angels and family offices to bring in more work-family life balance into businesses.
Spotlight
Protecting valuations & cap table chaos.
With a challenging dealmaking environment, more founders are turning to structured term sheets to escape down rounds and attract new capital. Bloomberg reported this week that some startup shares are currently selling at a 61% discount to attract VC investors. But the new terms are not friendly for everyone, especially not for early backers. The conflict is especially visible at startups that bring new investors who insist on stacking their preferences and that so far have raised capital with equal terms for all investors. Founders and investors may be inclined to add more structure instead of lowering a startup's valuation, because down rounds can have negative consequences, such as demotivating the team or impacting the valuations on investment managers' books.
This is just one of the startups’ headaches in the shifting dealmaking environment these days. Investors are now requesting more board seats, preferential terms, increased structure, including increased liquidation preferences. VCs say they're seeing more pay-to-play provisions and bridge rounds quietly closing with liquidation preferences as high as 4x. In Q1 2023, nearly 9% of the 899 deals recorded by Carta closed with a liquidation preference exceeding 1x. In comparison, last year this figure was less than 2%. Another example are cumulative dividends. According to the recent data, there has been a 6% increase in those provisions since last year.
Startups that secured significant funding in 2021 and cut their costs considerably in 2022 may still have some cushion before they need to fundraise on new terms, but the impact of cost-cutting measures is starting to fade. Read full story ➯
Fundraising
Dry powder misconception.
I have been asked a few times in the past weeks by founders: “Why are VCs not investing as quickly as they used to, even though there is still so much dry powder?” Let’s break down what is happening.
The VC “2/20” fee model means that 2% of LP committed capital gets paid out to VCs in a form of a management fee - that pays for a VC fund’s salaries, office, travel etc. Once a VC firm has invested 50-75% of capital during its investment period, a fund enters a follow-on period, in which investors are usually only allowed to make investments in existing portfolio companies - that typically happens after 3-4 years after raising a fund. Recycling is also no longer allowed - capital from any exits is distributed to LPs.
Now, once a VC firm enters a follow-on period, the management fee is often charged on the amount of invested capital, with exits and write-offs reducing this amount, which in turn means a smaller management fee.
In the past few years, when it was easy to raise LP capital, VCs were very keen to deploy quickly and hit the ‘Switch Date’, as only then would they be allowed to make new investments from new funds, and charge full management fees on top of the lower fees on the prior fund. But today, things are different. With higher interest rates and few exits, VCs actually have a much harder time raising a new fund - and deploying their fund quickly puts them in danger of hitting the ‘Switch Date’ early, resulting in a lower management fees to pay for their ongoing operations.
So yes, even though there is lots of dry powder, until we see the VC fund fundraising environment significantly improve, startup investing will also be slow.
Analysis
Follow on funds are rarer than you think.
Recently published data shows that around 20% of first-time funds struggle to secure follow-on funding. While first-time managers face challenges in raising follow-on funds, it does not necessary mean that their end-of-fund performance is any worse than that of an established fund. What is the reason behind the drop-off? First-time fund managers often lack the financial resources required for their general partners to commit to establish a follow-on fund. Follow-on funds typically require more capital and necessitate a different set of LPs and networks compared to first-time funds. Additionally, first-time fund managers may not continue their efforts if the GP team fails to align on a follow-on fund strategy, causing the group to dissolve. Finally, the initial investment strategy implemented in the first fund may not be replicable in a follow-on fund due to increased competition or market trends.
Where you are still matters.
Even though over the past few years, many VCs have been expanding their investment strategy from a local to a Pan-European play, a location of a startup still dictates its access to funding, talent, expertise, innovation opportunities, growth prospects, networking, infrastructure, regulatory frameworks, and potential exit opportunities - the list is long. Startup Genome recently published a report that assesses the present state of startup ecosystems worldwide. London still leads the way as the most attractive startup ecosystem in Europe - its position has not changed since 2020. London is followed by Berlin, Amsterdam, Paris and Stockholm, while Zurich has shown remarkable progress, leaping up by 10 spots to number 36.
From the Community
TechBBQ x Female Foundry
Female Foundry is an official partner of the TechBBQ in Copenhagen, the annual conference focused on the Nordic startup and scaleup ecosystem, taking place on the 13-14 of September, and we have a 30% promo code on all ticket types to the Female Foundry community!
To receive the code, send me an email by replying to this newsletter. Get your tickets ➯ here.
Hiring
This week hiring:
FreshSound ➯ Account Manager | Pai ➯ Key Account Manager UK & US | Green Got ➯ Content & Community Manager | Prewave ➯ Key Account Manager.
See more jobs on the Female Foundry Job Board.
Founder & Investor Meetups
Wednesday, June 28, Berlin ➯ Finding Product-Market Fit, Amsterdam ➯ Investor round tables | Thursday, June 29, Berlin ➯ Techstars Demo Day - Mobility, London ➯ Allia’s Female Founder Demo Day.
That’s it for this week. See you next weekend!
Agata
Written by Agata Leliwa Nowicka, an investor, a startup adviser, a two-time entrepreneur, and a founder of Female Foundry based in London.
Suggestions? Drop me an email.
Check femalefoundry.co for more fundraising tools and investor content. View other Female Foundry articles.