The Funding Rounds Method
In the old days, up until 1995, there was only the funding rounds method.
Here is how it went: each time we needed to distribute a securities issue we were fixing a price according to the current state and valuation of the company who was the issuer.
The main problems with the funding rounds method were the following:
- If the company was mismanaged or could not achieve its initial objectives or was simply running out of money, new investors would buy shares of stock at a lower price than the earlier investors, while new investors still have less risk.
- All investors wanted to be the last one and not be the first to invest, so the process was extremely slow.
The funding rounds method is now a thing of the past.
The Incremental Price Method
In 1995, while raising money for my company, I invented the Incremental Price Method. Here is how it goes:
- The issue of securities is divided in three to five tranches.
- The price of each tranch increases of at least 30% more than the previous one.</li
- When a tranch is sold, the investors who want or need to exit can sell their securities at a profit to new investors at the same new price or slightly below.
The main advantage is that if the company is mismanaged or could not achieve its initial objectives or iss simply running out of money, new investors will still buy shares of stock at a higher price than the earlier investors who took the biggest risk.
What about Equal Treatment among Investors?
The principle of equality not only states that every investor in the same situation must be treated equaly, but also that every investor in a different situation must be treated differently.
Except for a few exceptional cases, when an investor invests several months or more than one year after another, he or she cannot possibly be in the same situation as one who invested several months or less than one year ago.
Thus it is right for new investors to pay a premium over earlier investors.