Flat Rounds – What Are They?

What exactly is a flat round?

A flat round occurs when a company is raising finance at the post-money value of their previous fund raise. For example, if company A previously raised £500,000 at a pre-money value of £2,000,000 and are now raising another round at one of £2,500,000, this would be considered a flat round.

Flat rounds are not uncommon; around half of follow-on’s I have tracked had flat rounds.

Why people fear the flat round

Flat rounds are often associated with companies that are performing poorly and can be a signal that something is not right with either the team or the product. Most flat rounds occur when money is running out but the milestones/targets that were meant to be hit have not been achieved. Other times, a flat round may occur because the market fit was not right for the product, or the technology was too early and the market not yet fully developed. The company is running out of money so it needs to raise or risk going out of business.

In principle, they haven’t achieved what they said they would so they cannot justify a higher valuation.

Beyond the lack of milestones/progression to justify an up round, there is an accompanying psychological element to a flat round that must be considered.

In effect, with a flat round the founders are being further diluted (ie their share holding getting smaller), as are the original investors – and some take this to heart. As Dennis Keohane, former Senior Staff Writer at The Boston Globe, puts it, ‘Start-ups are as much a mental game as anything else, and it’s demoralising to toil away for a year only to hear that you’ve somehow destroyed value in the thing you are creating.’

The post-raise impact of a flat round must be monitored closely and, the right set of incentives must be given to ensure the entrepreneur is still fully committed to the cause.

Despite all of the above, a flat round does not necessarily mean that the company is not investable.

Quite the contrary: in some instances a flat round may provide a better opportunity for investors, particularly as it can serve as a form of market correction. Early investors may have invested at a high valuation as a result of the hype surrounding the idea. While the milestones and targets may not have been hit, that does not mean that the idea has lost value. But, as the company requires more money to hit the objectives, an investor can re-invest at a potentially fairer value, in a company that is further along than it was when the original investment took place.

How to approach a flat round

Flat rounds are tricky, so the best thing to do is approach the round as if it were a new company and a new round. Would you invest if this was the first round in which you were asked to?
If your answer is ‘yes’, you then need to take into account what you do know. Does the team work hard? Do the founders still have a passion for what they’re doing? Do they communicate with you well? This is one of the most annoying issues. I have invested through crowd funding websites but have never heard from the website or the company again. I am deemed a Sophisticated Investor and if there was another round, they would be in touch. I want to know updates good and bad ready for any follow up round, so I am not diluted and follow my investment in all cycles.

A flat round should never come as a surprise and, if it does, the entrepreneurs have not done their job properly.

It’s fair to say that if the technology is still right, if the market is forming and if the team members are just as passionate about what they are doing, you would go for more.

When shouldn’t you follow-on in a flat round?

There are four main reasons why one might not participate in a flat round:

When one has lost faith in the ability of the team to deliver

Some companies have all the stars aligned for them and then fail to execute. Some make excuses, some make repeated mistakes. An entrepreneur should always own up to their mistakes, and prove that they have learned from them and will not make them again.

When the technology just can’t work

There are times when, regardless of how sound the idea, there is just no way to bring it to life. Some entrepreneurs really are too far ahead of their time and it’s best to leave the venture where it is, and maybe in a few years other advancements will occur that enable the project to be revisited again.

If one of the founding members leaves

Angels back teams and, generally, when one of the founders leaves it’s a pretty big indicator that not all is well in the company, regardless of what the remaining founders say. There are some valid reasons why a founder may leave but, in most cases, if one goes, the investment goes.

If they have never communicated with you since they got your cheque

The management believes they have your money and you simply let them get on with it and they do not want to share their “secrets” good or bad. Most start-ups keep dreaming with a cup half full, most seasoned investors know every venture investment is looking at a cup half empty and if they get a winner, it makes up for many losers.