Key considerations when raising expansion stage capital

Venture-backed technology startups that have reached expansion stage have attained a significant level of success as defined by milestones such as customer adoption, shipment of a flagship product, revenue generation and execution of a marketing plan.

In pursuing an expansion stage raise (typically a Series C or Series D), the issuer plans to use the funds to scale, generally through international expansion, grow by acquisition or launch new products. Plans for scaling up usually translate into a significantly larger raise than in prior rounds, and given that existing venture backers likely specialize in development stage rounds, the issuer will usually seek one or more new investors to cover the lion’s share of the raise.

To-Do List

Given the current challenging financial climate, and its impact on prospects for startups in all stages of development, the issuer’s management and board will be well-advised to heed the following guidelines, as verified from discussions with private placement professionals and VCs, when seeking to raise expansion stage capital:

• Monitor market conditions closely and adjust expectations accordingly. The road to raising money has gotten considerably tougher, even for successful expansion stage candidates. The economic landscape has caused considerable skittishness among investors and ultimately resulted in significant reductions in valuations from what issuers and placement professionals envisioned as recently as the end of Q3 2008.

The road to raising money has gotten considerably tougher, even for successful expansion stage candidates.”

A critical question with respect to soliciting new investors in the expansion stage is whether to engage a private placement agent or go it alone with the help of introductions from current investors and service providers.

Certainly, using a placement agent with deep industry investor contacts can raise the breadth and depth of solicitations, as well as help increase or meet the expected valuation, while significantly freeing the company’s CEO and executive team to run the business during the process.

That said, a placement agency can be expensive. Depending on the perceived ease or difficulty of the fund-raising, agency fees will typically be 6% to 8% of the offering amount, often with a nonrefundable retainer of $25,000 to $50,000 plus coverage of the agent’s expenses. In addition, agents will typically demand a minimum fee regardless of the raised amount, and tail coverage for some period after the engagement has been terminated by the issuer—even if the agent has been unsuccessful in raising capital.

If one does engage an agent, it’s best to heed the following guidelines in choosing one and negotiating the terms of the agency engagement:

• Focus on how well the agent understands and knows the company’s strategy and can translate and defend its material elements. The agent must be able to step into management’s shoes in the solicitation memoranda, presentations, and follow-up with the investors.

Great care should be given to generate sustainable financial plans ahead of solicitations, even if this means delaying the process.”

• Ensure that the agency fee excludes any amounts raised in the new round from the current investors.

• Require the agent to obtain the company’s consent before spending in excess of pre-determined amounts.

• Limit the tail coverage for a period of nine to 12 months after termination and require that the sale be made to an investor that the agent introduced during the engagement.

Founder Liquidity Issues

The expansion raise also provides an opportunity for founders to liquidate some of their vested equity in the issuer. While the company and the current investors most likely possess traditional preemptive rights on the transfer of founders’ vested shares, the company’s management and board will commonly consider and allow liquidity on a limited amount of shares as part of the raise (referred to commonly as a secondary sale).

Management and disinterested directors must assess any such allowance to ensure that providing liquidity to a founder is not a disincentive to his or her performance at such a critical stage of the venture, especially to the extent he or she is a key employee. As such, the amount allowed for such transfer is typically between 5% to 10% of the founders’ shares.

William “Bill” Choe is a Silicon Valley-based partner, and Peter “Chip” Korn Jr. is a New York City-based partner of law firm Sonnenschein Nath & Rosenthal. Both work in the firm’s Venture Capital and Emerging Growth Company Group. Choe may be reached at and Korn may be reached at