Last month (see my October 2006 column) I introduced the concept of using a "parsing strategy" -- identifying a series of specific milestones or events that could significantly increase business valuation, and raising only the amount necessary to reach the next milestone -- essentially allowing you to bring in equity investors without giving away the store. This month we'll take a closer look at the factors to consider when contemplating a parsing strategy.
In the broadest sense, when you parse a financing, you divide the total amount of money that you will need to accomplish your ultimate goal into a number of smaller, discrete portions that will be needed at different times. You maximize the benefits of parsing by identifying specific milestones or events that cause a significant increase (appreciation) in the valuation of the business and correlate rounds of financing to those events. These are natural "breakpoints" for financing. Rounds of financing occurring after the "breakpoints" typically cost you less than earlier rounds. What sort of events am I talking about? Examples include proof of concept, completion of a prototype of your product or technology, filing a patent application (or better yet, obtaining a patent grant), completion of product development, completion of market research, a product launch, a major contract or customers, or filling out the management team.
The securities law may also factor into the timing of successive rounds of financing. If sufficient time passes between rounds, breaking the financing into smaller amounts may permit you to take advantage of certain exemptions from some of the more onerous obligations (such as the registration requirement) imposed by the securities law.
The affect of asking for the smaller amounts on the potential sources of other people's money (OPM) available to you also must be considered. How do the smaller amounts fit with the range of investments made by your potential sources of OPM? Smaller amounts may take you "beneath the radar screen" of your potential sources of OPM (venture capitalists), but may make other sources (family and friends, angels) available to you.
As valuable as a parsing strategy may be, however, it is not appropriate in every instance.
In any event, parsing is a powerful tool, but it should be employed as part of a carefully planned financing strategy.