In Defense of Party Rounds
by Jarrett Streebin
October 23, 2014
Every quarter or so there's a new post about why you shouldn't do a Party Round. Googling "Party Round" will bring up a handful of them. A party round is when a company raises from a relatively large group of investors, say 10+, and no investor takes a board seat and/or makes a substantially larger investment than the rest of the investors.
Given how awful they're supposed to be, and the lack of posts by companies that have raised one, we thought we'd write down what our experience has been raising a party round. From our first check from SV Angel to our most recent, we've raised over $3m from over 40 investors. Since no investor gave us more than $250k on over $3m total, and since no investor took a board seat, this would be considered a "party round".
The most frequently mentioned argument against party rounds is a lack of "skin in the game" by the investors. It's the idea that since there is no lead investor--one taking up a major chunk of the financing--there are no investors with sufficient skin in the game. Since no investor will have a board seat or an investment that's sizably bigger than the others, each individual investor won't care that much about the company.
An implied reason in the "skin in the game" argument is that the investor makes the company successful. If an investor had enough skin in the game they could lead the company to success. Although we have incredibly helpful investors whose belief in us has helped tremendously, I don't believe they make the company. Or that their lack of skin in the game dooms the company, especially not at the seed stage. I do believe in later rounds, where party rounds don't really exist, the investor matters more. But remember, great companies aren't defined by their investors, but great investors are defined by their companies.
Another argument is around fundraising. It's often said that a lack of lead investor will make further financings more difficult. There is also the issue of setting the terms. If there will be many small investors, it can be tough to properly price the round. You could get to a point halfway through the round and have investors disagree with the price.
Despite those and other potential pitfalls, our funding structure has successfully helped us grow our business. Four times as many people work at EasyPost as when we closed our round and we've grown our volume more than 25x in the last twelve months. We've yet to raise a Series A, so I can't comment on later rounds, but so far it's working.
As far as skin in the game is concerned, having our skin in the game has been sufficient. After all, investors are in the business of making many bets, with respect to companies. As a founder, I'm in the business of making a single bet. That's more skin in the game than any venture investor will have, since their model is to put some skin in a lot of games.
My sense is that this is may be a holdover from an older era of VC in which investors sought and often demanded large measures of control. This was often used so they could enact what they thought was best, be it for the company or the investor themself. This included selling companies, firings, et cetera.
The other advantage to this is that we control our board. In our experience, the max amount of time we knew an investor before they invested was about two months. That's only say 3-6 meetings or calls at most.
Is that enough time to pick an investor and board member for the life of your company? What if you make the wrong choice? This hastily chosen board member will now have significant control throughout the course of the company, and there's not much recourse if there isn't a good fit between a board member and company.
In our position, we've now seen and worked with many investors and can carefully choose who we want on our board. We also aren't beholden to any lead investor for further financing. This is another major area where potential negatives can outweigh the positives.
Let's lay out a positive scenario for follow on financings with an established lead investor: company seeks additional capital and lead investor provides it on amicable terms. Round is closed, everyone is happy.
Now let's look at some potential negatives: a) lead investor agrees on timing of investment but disagrees significantly on terms; company can either take the terms, seek outside funding with a negative signal since the lead investor didn't agree on terms, or not raise money, b) lead investor disagrees on timing of investment (maybe they're waiting for a fund to close or aren't sufficiently excited about your business prospects); company must outside capital with a negative signal since lead investor didn't follow on, or c) lead investor is not interested in a follow on investment; company is left to seek outside investment with a negative signal.
As far as we can see, the potential negatives heavily outweigh the potential positives. We've yet to find investors met our preferred terms without signifcant leverage, so it also seems the potential positive scenario is a bit unlikely without outside bidders.
In our case, should we need additional financing we have 10-20 institutional funds that are already investors. We've gotten to know them over their months and years as investors. This has given us significant time to both prove our value as a company to them, and for them to prove their value to an investor to us. Also, should we seek financing outside of our existing investors, we're able to do so without a negative signal since none of them lead the round.
When it came to actually setting the terms, we learned to be flexible. Pick a price that gets a yes. Worst case, you get a few yeses and then a string of no's so you lower the price and rewrite the terms for the initial yeses. Everyone will be happy.
A potential negative arises with respect to setting terms, since there will be no lead and the company needs to get many investors to agree on terms. What we found is that the lead investors often want preferred terms given their sizeable investment. We also found that we didn't have to get all the investors to agree to terms at the same time, just one after another.
What got us started on this post was that most of the anti-party rounds' posts were by investors, and we hadn't heard a founder say a party round was bad for them. Given that, we thought it was worth weighing in since our experience has been mostly positive.
As you can see, there are plenty of pros and cons about raising a party round. This isn't meant to be the final word. Like our previous post, this is just our experience. But we'd be remiss if we didn't point out a few of our positive experiences in the sea of supposed negatives.