With an investing CV that marks him out as UKBAA ‘Angel Investor of the Year’ for 2014/15, one of Angel News’ ‘10 Business Angels You Should Know’, a member of the investment committee of the Angel Co-investment Fund and the Investment Director at Martlet, the Corproate Angel Division of Marshall of Cambridge, Peter Cowley is one of a small number of rising ‘Super’ Angels operating in the UK.

While Peter has investments in the biotech, medtech, ICT, web, fire safety, electronics, mobile data, aerospace, printing and instrumentation sectors, it’s not just his angel experience that is extensive. Peter is a Fellow in Entrepreneurship at the Cambridge Judge Business School, has founded 12 companies and is a non-executive director/board observer of seven.

So when Peter agreed to come on the show we decided to broach one of the trickiest angel investing topics we could: the oft-feared flat round.

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; of the 45 companies that Peter has invested in there have been 43 follow-on rounds. Of these follow-on rounds, 17 have been 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. As Peter puts it, 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 principal, they haven’t achieved what they said they would so they cannot justify a higher valuation,’ explains Peter.

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, as are the original investors – and some take this to heart. As Dennis Keohane, former Senior Staff Writer at The Boston Globe, puts it, ‘Startups are as much a mental game as anything else, and it’s demoralizing 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, as Peter points out, 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? 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, people like Peter will likely follow their money.

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

There are three main reasons why Peter will not participate in a flat round.

1. When he 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.

2. 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.

3. 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.

In closing

We’d love to open up the topic of flat rounds to all of you in our network. If you’ve got experience with a flat round and agree (or disagree!) with Peter’s insights and approach, do join in the debate below.

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