In many investment rounds, there is a certain range of capital that the company is asking to raise. For example, in seed rounds, many companies seek to raise a minimum of $500,000 but not more than $1,000,000. The idea for having a minimum amount is that the startup needs this amount to achieve the next milestone, and thus investors won’t be willing to invest unless this amount is raised. The reason for having a maximum amount is that the startup prefers having some extra cushion, but at the same time the founders don’t want to get over diluted.

(Note: there are other cases of ‘rolling rounds”, which I won’t cover in this post for the sake of keeping it simple).

In many cases, the best way to raise capital within a certain range is to first close the minimum amount and then try to raise the remaining amount. In startups’ terminology, this is called a ‘rolling round’. However, this tactic creates a problem. A wise investor would always prefer avoid being the first to invest, and would rather wait until others invest first.

To solve this problem and attract investors to be the first to invest, it’s very common to offer a discount on the price per share. This way, the earlier you invest the more discount you get. So the question is how much discount you should give. The most common formula for a rolling round is as follows:

You start counting the time from the date that each investor invested. If the round closes within 30 days from that date, then the investor doesn’t get any discount. After that you give a 5% discount up to a maximum of 25% after another period of 5 months (i.e. 6 months since the investor's investment date). (Note: A maximum of 30% discount is also fine if you have no other option [i.e. after a total of 7 month since the investment date]).

The formula to calculate the discount rate for each investor is:

[Discount Rate] = Min { 25% or: ([Number of full month between investment and final closing] -1) X [% discount rate for each month]}

Let’s look at a two example. In both we’ll assume that there’s no discount for the first 30 days and there’s a 5% discount for each additional month, up to a maximum discount rate of 25%.

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Labels: Fundraising, Investment Terms