Listed on the profile of every company raising on SeedInvest is an important dollar figure in the Term Sheet: the target minimum. When investments are initiated through the SeedInvest platform, the subscription proceeds are held securely in a third-party escrow account pending a successful closing. Once all the closing conditions have been met, the money is released to the company and investors will receive the applicable securities. It’s vital that the company reach this target by campaign end, otherwise committed funds will be promptly returned to investors, and the company won’t be able to close on any of the capital raised on SeedInvest. To find out more about the startup investing process, visit our Academy.
The escrow target varies on a deal-by-deal basis. It may be as low as $100K or as high as several million dollars. Compared to other equity crowdfunding platforms, the target minimums found on SeedInvest are often 10-100 times higher. Yet this seemingly arbitrary number is actually one of the most important terms of a company’s raise.
How is it determined?
Long before a company launches its raise on SeedInvest, it must first go through our Investment Committee approval process. This internal business due diligence is comprehensive, covering multiple facets of a company including its team, product, market, traction, and raise terms. Among some of the most important considerations during the diligence process are a company’s financials, including its historical P&L, current balance sheet, and projections.
When a company decides to raise capital, the founders typically have an ideal number in mind, however most companies will end up raising less than this. Taking this into account, during the due diligence process it is important to review a company’s current cash position, how much capital it has burned through over the past year, and the projected burn post-raise. Leveraging this, and with additional input from the company, the Investment Committee sets an escrow target that the company must raise on SeedInvest (and from any offline investors, such as VC funds or angel groups) for their raise to be deemed successful.
Why is it so important?
At SeedInvest, we want any company that successfully closes on our investors’ capital to typically:
- Have at least 10-12 months of runway at the fundraise end
- Have sufficient capital to achieve enough growth over the next 10-12 months to be well positioned to raise a subsequent investment round or reach breakeven
Traditional venture capital funds can ensure this is the case given the size of their checks, or by waiting to invest until other funds have committed to do so. The unique nature of equity crowdfunding means there are no such safety nets, and so a target minimum needs to be established to ensure similar protections are in place.
The last thing an investor wants is to invest in a company that is setup to fail. Setting the right target minimum helps offset some of the risk that a company folds shortly after raising capital due to cash flow issues. To that end, if a company has a high burn rate, or if its future strategy necessitates it be capital intensive, a high minimum target is likely appropriate (and if cash flow positive, a lower target may be more appropriate).
The startup asset class is risky, most startups fail, and only a select few will deliver outsized returns. In light of the inherent risks, it is important that investors are afforded the advantages traditional VC investors have wherever possible. In ensuring investors are able to deploy capital into companies with a fighting chance, setting the right target minimum is an important step towards achieving that end.
This post was written by Nico Leeper on November 11, 2019
What is an Escrow Target?