Reasons For An Inside Round

 
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Explaining Venture Capital: "What Are The Reasons For An Inside Round?"
September 3rd, 2013 - By AdExchanger

Gil Beyda is Founder & Managing Partner at Genacast Ventures. His firm's investments have included Invite Media (acquired by Google in 2010) and Demdex (acquired by Adobe in 2011).

AdExchanger asked Mr. Beyda to explain a fundraising tactic increasingly used by advertising technology startups known as an "inside round."

In venture capital, an "inside round" is additional investment that is made by a company's existing investors. From outside a company, it is difficult to know why it was done or whether a company is doing well or not.

Here are some reasons for an inside round.

  • Investors want to own more of a great company. If a company is doing well, existing investors will lead an inside round so as not to share the deal with outside investors and dilute their ownership. Outside investors are sometimes shown the company anyway to get a market price (valuation) and then the deal is done internally.
  • If the board of directors, investors and company work well together sometimes it is best not to "rock the boat" by bringing in outside investors and board members. Internal company dynamics are a delicate ecosystem that can be a great asset to a company but also a liability. An inside round would preserve good working relationships with these key constituents.
  • Raising capital is time-consuming. A CEO is on the road for months, flying from coast to coast and meeting with dozens of investors. This is a distraction for a CEO who is not able to focus on the company. Taking an investment from existing investors who already know the company, perhaps even sit on the board, is much less time-consuming and can typically close in a few weeks. Little diligence is necessary and the last investment documents are used. The downside for the company is that without outside competition the valuation is sometimes lower than market.
  • The company needs a little more runway to get to a much higher valuation. Rather than do the round now at a lower valuation, the existing investors put in additional capital. This gives the company more time to hit some milestones at which time the company will go for an outside round at a higher valuation.
  • Internal investors might be mildly excited to invest in the company but decide to show their support and offer to invest anyway in the hopes of getting outside investors exited. Also, insiders can act as competition and cause outside investors to increase their valuation. Sometimes this strategy backfires on internal investors. Significant outside interest might reignite the insiders' interest but now they need to match or beat the outsider's higher valuation.
  • The company might be doing well, but perhaps relied too heavily on a big deal which didn't materialize causing the company to run out of cash. It is still a good company, but is desperate for cash which is a bad position to be in when raising capital. The insiders bridge the company with an inside round to meet its short-term cash needs.
  • The company is not doing well and outsiders are not interested in investing. Rather than let the company go under, inside investors are willing to put in more capital to protect the asset from becoming worthless in the hopes things will turn around. The valuation will be much lower than market to account for the distressed nature of the company.