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Late-stage startups are gaining clout, shrinking the power of investors

Posted by Grace Townsley

August 13, 2021 | 3-minute read (569 words)

An exuberant man in a red crew-neck sweatshirt

Mature startups are starting to take their power back. Rather than relying on a lead investor to help secure funding, often forcing the entrepreneur to hand over some level of control over their own company, an increasing number of startups are setting their own valuation and hosting their own fundraising rounds. Is this power reversal movement set to become a long-term trend?

Background

Late-stage startups, also called Series C, are companies that have been successfully in business for a few years or more. Companies at this level are already on their way to profitability, their market has taken notice of them, and they just need an extra round or two of funding to keep scaling up quickly. These companies tend to have a fairly stable business model which helps them attract the funding they need.

For companies like these, conventional entrepreneurial advice says to find a lead investor as soon as possible during the startup phase of a company. This key leader, and largest capital investor, is critical to give the startup validation and to attract further investment. In fact, many lower-level investors will not consider seeding a startup until the startup has a significant lead investor backing it. However, having a lead investor is not a requirement for funding. And a growing number of late-stage startups are taking advantage of this freedom to run their startup their own way.

The potentially controlling role of the lead investor

Besides rallying other investors, the lead investor also sets the term sheet and the post-money valuation for the startup. In other words, they decide what benefit investors get for seeding the startup, and they decide what the startup is worth before and after each round of fundraising (the valuation). The lead investor may also require a seat on the board of directors and power to advise the startup’s decisions and purchases. This influence can greatly impact the direction the company is going. So, with this great infusion of capital comes a loss of control for the entrepreneur.

Until recently, fundraising without a lead investor was nearly impossible. Smaller investors demanded the social proof and validation that came from having a prominent lead investor. Knowing a successful investor has already deeply vetted the company was the main selling point for startups hoping to secure future rounds of capital.

Startups looking to fundraise without a lead investor can seek independent valuation for their business. Common first steps include working with a CPA, a business adviser and a real estate agent if the startup includes property. This ensures an accurate valuation that isn’t skewed by the entrepreneur’s optimistic bias about their business.

A slow-but-notable shift in power

While fundraising without a lead investor is far from commonplace now, an increasing number of late-stage startups are opting for the independence to maintain full control of their business. For many young companies, the loss of power to operate their startup the way they choose is not worth the inflow of funding. With fewer late-stage startups heading into Series C funding with a lead investor, smaller investors are being forced to consider seeding these independent companies in a new way.

As more startups pursue their own paths to growth, it’s likely we will see a broader acceptance of independent fundraising. And with the boom in crowdfunding activity, it’s easier than ever to find small investors willing to seed the next big startup.

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