Venture Bridge Round with a Participating Preference
A growth-stage venture fund holds 18% of Helio, a Series C enterprise software company with $40m ARR growing 35%, gross margin 78%, and monthly net burn of $3m. Helio has nine months of cash and needs a $20m insider-led bridge to reach cash-flow breakeven in 15 months. The lead existing investor proposes a $20m round at a $160m pre-money valuation, half as convertible notes with a 20% discount and half as preferred with a 2x participating liquidation preference. The fund's 18% stake was acquired at a $240m post-money; the fund's cost basis is $28m. The fund has $60m left in its current vehicle and a 15% reserve target for follow-ons. A strategic acquirer has informally indicated interest at $300m but no term sheet. The fund must decide whether to participate pro rata, pass, or lead a larger round.
1. Assess the proposed bridge terms and whether the fund should participate, pass, or lead a larger round.
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The bridge is expensive and misaligned. A $160m pre-money is a down round from the $240m post-money, so existing holders face dilution and possible anti-dilution adjustments. The 2x participating preference gives the lead investor a priority return and then a share of residual proceeds, which is costly for common and for earlier preferred holders. The convertible notes with a 20% discount convert at a lower effective price, giving note holders a better deal than the preferred buyers.
Helio has nine months of cash but needs 15 months to breakeven, so $20m may not be enough. The fund's reserve target is 15% of $60m, or $9m; a $3.6m pro rata cheque uses 40% of that reserve. If the company needs a second tranche, the fund could be forced to choose between dilution and over-concentration. The informal $300m acquirer interest is not a term sheet and should not anchor the decision. Recommendation: participate only if the fund can lead or co-lead a larger $30-35m round that extends runway beyond 15 months and if the preference is reduced to 1x non-participating. Otherwise pass and preserve reserves for a later tranche or another portfolio company.
2. Calculate the approximate ownership and cost if the fund takes its pro rata share of the $20m round, and compare it with passing.
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The fund's pro rata share is 18% of $20m, or $3.6m. On a $160m pre-money plus $20m of new money, post-money is $180m. Existing holders are diluted by 160/180, or 88.9%, so the fund's 18% becomes 16.0%. If it invests $3.6m at the same price, it buys 3.6/180, or 2.0%, restoring ownership to about 18.0%. Cost is $3.6m, leaving $56.4m in the vehicle, but the $9m reserve target is now 40% used.
If the fund passes, ownership falls to 16.0% and it preserves $3.6m for a later round, but it may face further dilution if the company raises again. The comparison should focus on the marginal return. At a $300m sale, the fund's 18% is worth $54m before preferences, against a $28m cost basis; the incremental $3.6m buys about $6m of value, a 1.7x gross return. That is not compelling for the risk of a cash-burning company with a participating preference. Passing may be better unless the fund can negotiate better terms or lead a larger, tranched round.
3. What protections or terms would you seek if participating, and how should the strategic acquirer interest affect the decision?
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Seek a 1x non-participating preference, or a cap on the participating preference. Require pay-to-play for all existing investors so the lead cannot gain outsize rights without funding its share. Structure the round in tranches, with the second half released on milestones such as $10m of additional ARR or 12 months of runway. Ask for a board observer or board seat, information rights, anti-dilution protection for existing preferred, and limits on the convertible notes' discount and maturity so they do not create a liquidity cliff.
The strategic acquirer interest should be tested with a confidentiality agreement and a standstill, but it should not justify a bridge on its own. If the acquirer is serious, seek a bridge with a sale-process covenant or a fiduciary-out provision. Otherwise, preserve reserves. The fund should also check whether a follow-on above a concentration threshold requires LPAC approval, and whether the down round triggers a conflict-of-interest review for the lead investor.