Milestone Funding: Proceed with Caution – Corporate/Commercial Law
United States: Milestone funding: proceed with caution
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My colleague Jordan Koss recently wrote a good article warning entrepreneurs about Milestone Vesting (Milestone Vesting – Generally avoid for the good of the team, Jordan Koss). His reasoning is solid and his conclusion solid.
Jordan’s perspective on acquiring milestones got me thinking about another aspect of high-risk/reward entrepreneurship: milestone funding. This is a funding structure sometimes used when high-risk/reward entrepreneurs and their investors struggle to agree on a valuation. Resolving these differences is often contentious, and setting up a staged funding structure can seem like an efficient way to get the job done. However, as with stage-based procurement, stage-based funding is best given a lot of space.
With milestone funding, the parties can agree that an initial tranche of funding will be followed by a subsequent tranche based on whether or not the company reaches a milestone. The second installment could depend on the achievement of the stage; alternatively, the evaluation of the second installment could depend on whether or not the milestone has been reached. Savvy readers (like mine) can imagine a variety of variations on the milestone fundraising theme.
Staged funding has been around for a while, and why not? In theory, this seems like the kind of creative problem-solving approach that high-impact entrepreneurs and investors are proud of. That said, staged funding generally causes more problems than it solves, for one or more of the following reasons.
First of all, setting milestones isn’t always as easy as it looks. Too often, in the interest of closing the deal, entrepreneurs and investors set milestones that they “agree” on, but of which they have different interpretations. This is one of the lesser problems with milestone funding, but one that has tripped up more than a few startups.
A more problematic aspect of milestone-based funding occurs when a milestone is set too far in the future. “Too far” may not be very far at all. Entrepreneurs and investors may think they know what they want the company to be when it grows, and all the milestones until then, but experienced people know that startups rarely stay on the same path. long time. Tying future funding to today’s milestones seriously undermines management’s flexibility to adapt to changing circumstances.
Finally, milestones are useful on well-marked and durable routes (hence the roots of the term in ancient Roman road networks). Having been in and around high risk/reward entrepreneurship and investing for nearly 35 years, I can’t remember the last startup that followed a well-marked and sustainable journey from conception to exit. Rather, they are businesses where today’s best approach on how to apply limited resources to success will likely change, if not tomorrow, surely before next year passes. But once a milestone is set, and something as crucial as the next critical capital slug is tied to it, it will take on a life of its own; a life that will likely be a major management distraction at best, and a corporate killer at worst.
Now, there are cases, I guess, where staged funding works. In my experience, however, they are rare. If you think your deal is one of the exceptions where milestone funding makes sense, be sure to choose a short-term milestone that can be defined very precisely – then cross your fingers that the growth trajectory of your startup remains aligned with the milestone until it is reached.
The content of this article is intended to provide a general guide on the subject. Specialist advice should be sought regarding your particular situation.
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