Why use tranches and milestones?
Sometimes it’s hard to find someone who will give you the total amount of money you’re asking for, all at once. This is where milestones and tranches come in.
The English Oxford Living Dictionary describes a “tranche” as “a portion of something, especially money”. A milestone is described as “a significant stage or event in the development of something”.
In capital raising, you can have finance based on milestones, where you and your investor agree on tranches (or portions of finance) to be paid each time your venture reaches agreed milestones.
Perth-based venture capitalist and industry mentor Matt Macfarlane from m15e ventures puts it this way.
“If someone were to come to me and say they would like $2.5m to start up their company, the first thing I would ask is what the money will be used for,” he explains.
“Then I will ask them what they could do with $500,000. Then when they tell me, I will suggest that goal could be a milestone. Then when they hit that milestone target, I will put another $1m in and when they approach the next capital raising milestone, I will put more money in, and so on.”
So why use milestones and tranches:
- Lower investment risk: From an investor perspective, the lower the risk, the more willing they’ll be to put cash in for a return. Therefore, they can put in a smaller amount at certain times and see deliverables on that amount, rather than risk all the capital. As the project gets de-risked, they will put more investment on the line.
- Link between progress and capital: As the business delivers promises and expectations, capital is added. So, there’s a linkage between the progress of the business and the amount of capital that is put at risk.
- Relationship building: Investment in tranches are important, particularly for small to medium business opportunities. They can make investors much more comfortable with the entrepreneur over time.
Defining and agreeing on potential milestones and tranches is not always easy. You might find it challenging to set milestones that seem a long way in the future or, maybe your enterprise seems too unpredictable to create known milestones.
- Get advice: With a complex structure for a deal, it is vital to get advice from someone who has done it before or, if you want a more expensive pathway, from paid corporate finance advisors.
Macfarlane says many founders are quite happy to share their stories and tales of woe about fundraising. Reach out. There are various groups around Perth that you can meet who have been involved in fundraising. There are also accelerator programs that give people access to mentors.
Don’t get lost in the shark tank
Programs like “Shark Tank” may provide some basic education although Macfarlane reckons these are based on extremes.
“Sometimes a founder will come along who knows the corporate finance game and gives as good as they get back to the sharks. Sometimes the sharks will really call out the inexperience of some founders,” he says.
He has seen some very experienced “sharks” put forward deals that the founders should not sign up for – deals with debt plus equity components where the investor knows that the debt ranks ahead of equity. If the deal is accepted by the founder, there is a potential the investor could later own the whole company.
This is why it is so important to understand structural considerations and get advice before accepting money that is offered to you. Build up your corporate knowledge so that no investor can take advantage of your enthusiasm.