- By Aaron Kellner
- April 2, 2018
- 5 minute read
Nearly one decade ago, Y Combinator co-founder Paul Graham published a short yet potent blog post titled High Resolution Fundraising. A novel concept at the time, High Resolution Fundraising was put forth as a means to solve one of the hardest chicken-and-egg problems faced by nearly all fundraising companies: in an asset class historically dominated by social validation, how do you get someone to be your first investor? As Paul correctly noted: “Any startup founder can tell you the most common question they hear from investors is not about the founders or the product but ‘who else is investing?’”
Paul sought to establish a new fundraising paradigm – one that rewarded risk-tolerant investors willing to make a wager before knowing who else they would be investing alongside – by offering different terms to different investors and increasing the relative attractiveness of investing early. Such a feat could theoretically be accomplished, for example, by quite literally increasing the valuation (or more specifically the valuation cap) the longer an investor held out making a final decision.
Paul’s blog post came at a time when the startup community was beginning its rapid embrace of convertible notes as a means to more quickly (and arguably more “efficiently”) fundraise. In fact, it was precisely this newfound and increasing acceptance of convertible notes that made a concept like High Resolution Fundraising even remotely possible. But while convertible notes themselves have become commonplace since the time of Paul Graham’s blog post – nearly half of SeedInvest offerings to date, for example, have been through the sale of convertible notes – High Resolution Fundraising never really seemed to catch on. In fact, a Google Trends search for the term results in an error message: “Hmm, your search doesn’t have enough data to show here.”
Given the relative dearth of discussion and dialogue on High Resolution Fundraising – absent a small flurry of articles and opinion pieces published in the wake of the original blog post – it would be nearly impossible to definitively conclude why this concept failed to take off. But as any experienced founder already knows, fundraising while trying to run and grow a business is a complex and time-consuming effort in and of itself. And even with the type of carrot that High Resolution Fundraising seemingly offered, adding an additional layer of complexity vis-à-vis varying deal terms on an investor-by-investor basis just wouldn’t and couldn’t be practical.
True to Paul Graham’s original intent, SWIFT (or “Simple Weighted Incentive for Time”) Financing was developed by SeedInvest to both reward those more risk-tolerant investors while simultaneously arming entrepreneurs with a tool to help build early fundraising momentum and smooth the road to a successful fundraise. But SWIFT Financing differs from Paul’s traditional notion in two important ways:
- SWIFT Financing leverages SeedInvest’s proprietary online investment platform – already used by hundreds of entrepreneurs to efficiently solicit and accept investments from tens of thousands of investors – to remove the above-mentioned complexities arising from trying to manually vary deal terms from one investor to the next.
- SWIFT Financing can be used by companies selling either preferred equity or convertible notes whereas High Resolution Fundraising was only applicable to the sale of convertible notes.
So how does SWIFT Financing work exactly? Below we will walk through simplified mechanics for both preferred equity and convertible note offerings. While doing so though, please keep in mind that the time periods and discounts mentioned are ultimately discretionary. The example figures below, therefore, are likely in practice to vary from one offering to the next.
SWIFT Financing with Convertible Notes
In the context of a convertible note offering, SWIFT Financing is strikingly similar to High Resolution Fundraising. The biggest difference is simply that while High Resolution Fundraising is designed to punish later investors with an ever-increasing valuation cap, SWIFT Financing instead seeks to reward early investors with a discount to a pre-established maximum valuation cap.
More specifically, investors are grouped into one of three tiers:
- Tier 1 represents the earliest investors – typically investing within the first two weeks of a company’s fundraise – who enjoy a 20% discount to the valuation cap at which the company is conducting its offering. So if a lead investor, for example, established a $5M valuation cap these earliest investors would instead invest at a $4M valuation cap.
- Tier 2 represents those investors who invest two to four weeks after the start of a company’s fundraise. Since these investors are still committing relatively early on, they’ll enjoy the benefit of a lesser valuation cap albeit one that is a bit higher than the one enjoyed by the earliest investors (e.g. around 10%). Continuing the above example, the investors in this middle tier would invest at a $4.5M valuation cap.
- Tier 3 represents investors who commit during the second half of the fundraise (i.e. more than four weeks after campaign launch). This group of investors simply invests at the terms established by the lead investor (i.e. at the $5M “fair market value” valuation cap in our example).
SWIFT Financing with Preferred Equity
The application of SWIFT Financing to a priced round may sound complex at first but in truth relies on a subtle yet significant distinction: the price at which a share is issued by a company does not necessarily need to equal the amount of cash an investor must lay out to actually purchase that share.
Generally speaking, these two figures have almost always been considered to be one and the same (if one issues a share for $1.00, for example, one would expect it to be purchased for that same price). But what SWIFT Financing posits is that there are actually two “currencies” that an investor transfers to a company upon investment: money and time. So instead of paying for that $1.00 share with $1.00 in cash, an investor could instead “pay” for that share with some combination of cash and “time”.
As was the case with convertible notes, investors are grouped into one of three tiers with the greatest discount offered to those who invest earliest:
- Tier 1 once again represents the earliest investors, who benefit from the largest discount. Assuming the same 20% discount and a $1.00 share price, these investors would effectively purchase that $1.00 share with $0.80 of cash and $0.20 of “time”. Important to note here is that because the true value of that share is still $1.00, these investors would be able recognize a 25% unrealized investment gain immediately upon investment.
- Tier 2 again represents the early majority, those committing during the first half of the fundraise but not the first two weeks. These investors would purchase that $1.00 share for only $0.90 of cash and effectively realize an immediate 11% unrealized gain.
- Tier 3 investors are those who wait until the last half of the fundraise to participate and – given the time elapsed – purchase their shares at their full issuance price. Once again, these investors are still investing at the “fair market value” established by the lead investor and so are not being punished in any way. They have simply decided to swap one form of currency (“time”) for another (cash).
SWIFT Financing may not be a fit for everybody. But for those companies seeking to speed up their fundraises and compensate their earliest investors (upon whom their raises are ultimately built) it most certainly represents an option worth exploring.
If you are interested in fundraising through SeedInvest or have questions related to SWIFT Financing please contact the SeedInvest Venture team at firstname.lastname@example.org.
This post was written by aaronkellner on April 2, 2018